Yield Curve Inversion & Other Economic Indicators (Finally) Signaling a Recession

4 min read

The yield curve is a critical tool for forecasting economic growth, and the recent inversion of the yield curve has been a clear indication of an impending recession.

An inversion of the yield curve occurs when the yields on long-term government bonds fall below the yields on short-term bonds. In such cases, investors become worried about the future economic prospects and demand higher yields on short-term bonds to compensate for the increased risk.

The yield curve inversion that occurred in March 2019 signaled that investors are anticipating a slowdown in economic growth in the next 12 to 18 months.

Furthermore, history has shown that yield curve inversions have preceded every recession in the last 50 years, making it a reliable recession indicator.

However, the yield curve is not a crystal ball, and there are some concerns about its predictive ability in today’s market.

For example, the current yield curve inversion has been a more gradual process than previous inversions, which may suggest that the recession may be less severe.

Additionally, central bank interventions such as quantitative easing can distort the yield curve, making it less reliable as a predictor of future economic conditions.

Therefore, while the trusted gauge of the yield curve is still an essential tool for analyzing the health of the economy, it should be used in conjunction with other economic indicators to develop a more comprehensive view.

What Economic Indicators To Look At Then?

  1. GDP: If the Federal Reserve has been hiking interest rates to control inflation, it may result in a slowdown in economic growth, which could negatively impact GDP.
  2. CPI: If the Federal Reserve has been hiking interest rates to control inflation, the value of CPI may decrease as the cost of borrowing increases. Higher interest rates tend to slow down economic growth, which can lead to decreased consumer demand, lower prices, and decreased inflation.
  3. Unemployment Rate: If the Federal Reserve has been hiking interest rates to control inflation, the value of the unemployment rate may increase as businesses respond to higher borrowing costs by slowing down their investments and hiring. A higher unemployment rate can also result from decreased consumer demand, as higher borrowing costs may reduce consumers’ purchasing power.
  4. Purchasing Managers’ Index (PMI): If the Federal Reserve has been hiking interest rates to control inflation, the value of the PMI may decrease as businesses may slow their investments and hiring in response to higher borrowing costs.
  5. Consumer Confidence Index (CCI): If the Federal Reserve has been hiking interest rates to control inflation, the value of the CCI may decrease as consumers may slow their spending in response to higher borrowing costs. Decreased consumer confidence can also result from a slowdown in economic growth, which can lead to job losses and decreased consumer purchasing power.
  6. Housing Starts: If the Federal Reserve has been hiking interest rates to control inflation, the value of housing starts may decrease as higher borrowing costs make it more expensive for consumers to purchase homes. This can lead to decreased demand for housing, which can result in a slowdown in construction activity.
  7. Stock Market Performance: If the Federal Reserve has been hiking interest rates to control inflation, the value of the stock market may decrease as investors may become less optimistic about the economy’s growth prospects. Higher borrowing costs can lead to decreased corporate profits, which can negatively impact stock prices.

In summary, while the Federal Reserve’s aggressive interest rate hikes may help control inflation, they can also have negative impacts on various economic indicators, resulting in a potential slowdown in economic growth.

It is essential to monitor these indicators closely to understand the overall health of the economy and make informed investment decisions.

Overall, the inversion of the yield curve is a warning sign that you should not ignore, and appropriate measures should be taken to mitigate the potential impact of an economic downturn.

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