An inversion can mean that investors see more risk in the short run than the long run. There’s a lot of chatter about the inversion of the yield curve and how it’s an indicator of an impending recession. The average lag is about five quarters, but the longest period between a negative yield curve and a recession was almost two years, and that was before the 2008 financial crisis. A flat yield curve is when long term and short-term rates are about equal (see 2007 below). Since 1978, we’ve seen the following inversions and subsequent recessions: Does an inverted yield curve cause a recession? The ‘yield curve’ is one of the most accurate predictors of a future recession – and it’s flashing warning signs. First let's look visually at the results: As you can see, there is definitely some nice predictive power here. The yield curve inverted in August 2006, a bit more than a year before the recession started in December 2007. This seems awfully simplistic to me in this era of advanced algorithms, surely we can do better than that. I used this report since it goes back quite a ways, it is consistent, and it’s free courtesy of FRED, Now I am not going to cheat as others would do and use some non-stationary time series data in my model. A yield-curve inversion is among the most consistent recession indicators, but other metrics can support it or give a better sense of how intense, long, or far-reaching a recession will be. Whether the inversion precedes the tightening or vice versa, what we know is that the yield curve inversion preceded each of the last 11 recessions, and that alone is strong evidence of correlation. A standard yield curve is upward sloping (see 2011 below). Basically, we are going to use the evolution of the yield curve to binary classify if we are in a recession or not. Recession fears at the time were quite high, as many yield-curve-based models were predicting elevated probabilities of a downturn. the difference between 10-year Treasury bond rate and the 3-month Treasury bond rate) is included in the Financial Stress Index published by the St. Louis Fed. The chart below shows how many months the yield-curve inverted before each of the recessions. Be Wary Of ‘Codetermination’, January 6th SBA Regulations Help Solidify PPP And EIDL Changes, SBA Issues New And Much Anticipated PPP Regulations, Loans become less profitable when short-term rates are higher, An inversion may signal a less-positive economic outlook. The yield curve is a chart showing the interest rate paid on bonds of different maturities. Yield Curve Blares Loudest U.S. Remember it isn’t the change in the yield curve that causes a recession. It also is an indicator of a disconnect in the outlook between the Fed and the market. Normally, more money is invested in long-term bonds, thus increasing their yield curve. The 'smoothing' of the yield curve indicates recession fears are abating, at least a bit. The yield curve … The so-called yield curve is perilously close to predicting a recession — something it has done before with surprising accuracy — and it’s become a big topic on Wall Street. From treasury.gov, we see that the 10-year yield is lower than the 1-month, 2-month, 3-month, 6-month and 1-yr yield. It should be noted that if we look at Fed funds rates after near-inversions or inversions, the Fed lags in lowering rates. It was on the basis of this indicator that in the November 2006 issue of my Remnant Review newsletter, I predicted a recession in 2007. Opinions expressed by Forbes Contributors are their own. I believe we all have human bandwidth, comprised of our time, money, happiness and love. If 2019 was the year the yield curve went mainstream, with an inversion sending a stark recession warning, then 2020 is already shaping up as a welcome return to normality. US Recession Watch Overview:. Yield curve inversion is a classic signal of a looming recession. An Inverted Yield Curve is used as one predictor of a recession as it captures the nervousness of investors about the near term market outlook. In fact, the yield curve usually begins to steepen during the recession. Now, you might point out that steepness measures the spread between the two, not the absolute level of yields. For example, the top five economic indicators that track recession dating by the National Bureau of Economic Research are initial jobless claims, auto sales, industrial production, the Philly Fed index and hours worked. The inverting yield curve is about more than recession this time. Remember that a recession is generally defined as two consecutive quarters of negative GDP growth. 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