cawacko
Well-known member
Inverted yield curves have been excellent indicators of past recessions but this article also points out how that could be changing and pitfalls to look out for.
Inverted Yield Curves Aren’t a Crystal Ball
Treasury yields serve as a bellwether for recessions, but don’t provide any new information on the economy
Don’t panic about the yield curve just yet.
On Monday, the yield on five-year Treasurys fell below that on two-year ones for the first time since 2007. Equity investors are now jittery about the prospect of a dreaded “inverted yield curve.”
Government bond yields broadly track where the central bank is expected to set interest rates in the future. So when long-term yields are lower than shorter-term ones, it typically reflects expectations of a collapse in economic growth. Historically, inverted yield curves have done a good job of warning that a recession is a few months down the line.
Still, they shouldn’t be trusted without question.
For starters, the inversion between two-year and five-year Treasury yields could be a temporary kink. In 1998, the gap turned negative without the rest of the curve following suit, and no recession followed. The most common measure of yield curve steepness is the difference between two-year and 10-year yields. This has also flattened but remains positive. A flattening curve itself has shown no predictive power.
Even if the full curve does flip, investors shouldn’t confuse cause for effect: Inverted yield curves don’t cause recessions, nor provide new information about the economy. They simply reflect a market assumption that growth will slow, based on how long the expansion has been going on and what data is available.
There is also no reason to believe that the yield curve remains reliable. Over the last decade, many traditional relationships between growth, inflation and interest rates have broken down. And Federal Reserve data suggest that at least some of the inversion has to do with supply and demand—investors bidding five-year notes more than two-year ones—rather than rate expectations.
Whatever fundamental view of the U.S. economy investors had before, they should stick to it whether the curve flips or not. That the yield curve is the most widely used recession bellwether says less about its predictive powers than about the limits of economic models.
https://www.wsj.com/articles/inverted-yield-curves-arent-a-crystal-ball-1543937678
Inverted Yield Curves Aren’t a Crystal Ball
Treasury yields serve as a bellwether for recessions, but don’t provide any new information on the economy
Don’t panic about the yield curve just yet.
On Monday, the yield on five-year Treasurys fell below that on two-year ones for the first time since 2007. Equity investors are now jittery about the prospect of a dreaded “inverted yield curve.”
Government bond yields broadly track where the central bank is expected to set interest rates in the future. So when long-term yields are lower than shorter-term ones, it typically reflects expectations of a collapse in economic growth. Historically, inverted yield curves have done a good job of warning that a recession is a few months down the line.
Still, they shouldn’t be trusted without question.
For starters, the inversion between two-year and five-year Treasury yields could be a temporary kink. In 1998, the gap turned negative without the rest of the curve following suit, and no recession followed. The most common measure of yield curve steepness is the difference between two-year and 10-year yields. This has also flattened but remains positive. A flattening curve itself has shown no predictive power.
Even if the full curve does flip, investors shouldn’t confuse cause for effect: Inverted yield curves don’t cause recessions, nor provide new information about the economy. They simply reflect a market assumption that growth will slow, based on how long the expansion has been going on and what data is available.
There is also no reason to believe that the yield curve remains reliable. Over the last decade, many traditional relationships between growth, inflation and interest rates have broken down. And Federal Reserve data suggest that at least some of the inversion has to do with supply and demand—investors bidding five-year notes more than two-year ones—rather than rate expectations.
Whatever fundamental view of the U.S. economy investors had before, they should stick to it whether the curve flips or not. That the yield curve is the most widely used recession bellwether says less about its predictive powers than about the limits of economic models.
https://www.wsj.com/articles/inverted-yield-curves-arent-a-crystal-ball-1543937678