Quick Bites | Doesn’t yield inversion mean recession? Maybe not …

For the last year, investors have been waiting for the imminent recession to arrive, often pointing to the presence of the US inverted yield curve as the harbinger of the slowdown to come. And yet, so far, it hasn’t come. At least not yet.

Perhaps a bit of background is required. Yields on long-dated bonds typically exceed those on short-dated ones, compensating longer-term lenders for the greater risks they face. But since last October, the US yield curve has been “inverted”: in other words, short-term rates have been above long-term ones (see chart below). This used to be regarded as a sure sign of impending recession.

The thinking is that if short-term rates are high, it is presumably because the US Federal Reserve (Fed) has tightened monetary policy to slow the economy and curb inflation. And if long-term rates are low, it suggests the Fed will eventually succeed, inducing a recession that will require it to cut interest rates in the more distant future.

Source: The Economist


This inversion (measured by the difference between ten-year and three-month Treasury yields) has happened 8 times in the past 50 years, and on each occasion was followed by recession. When the latest inversion started in October 2022, the S&P 500 reached a new low for the year.

Since then, however, both the economy and the share market have been amazingly resilient, if not buoyant. Of course, a recession may still be ahead – sometimes rates operate with a long lag. And there might be a nasty surprise of some sort up ahead. But there is also a growing possibility that a seemingly foolproof indicator has misled us. Perhaps “this time it’s different”. We hope so.



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