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CHART OF THE WEEK: THE “CRAZY INVERTED YIELD CURVE”!


21 August 2019

Bob Cunneen, Senior Economist and Portfolio Specialist

Sources: Federal Reserve Bank of St Louis, Federal Reserve Bank of Chicago and @realDonaldTrump, 14 August 2019.

 

Could President Trump actually be right by twittering about the “CRAZY INVERTED YIELD CURVE”? An inverted yield curve is where long-term government bond yields are below short-term yields (when the blue line falls below zero).

For investors, this is a major worry given that an inverted yield curve can signal that a US recession is coming. However there has been a considerable time lag that averages 15 months between when the inverted yield curve appears and when the last three US recessions started. So, the inverted yield curve is really a warning sign of danger ahead.

There are more timely signals that a US recession is approaching. Leading indicators such as business surveys, car sales and housing construction typically turn down before the recession hits. Credit conditions can also signal tough times ahead as banks tighten lending standards. Combining these two indicators gives an average five months early warning signal (red line). The current good news for the US economy is that this indicator is still in positive territory and is consistent with mild economic growth.

So, the bond market’s yield curve will be considered crazy unless the recession actually occurs. However, the problem for President Trump and investors is that if the bond market is finally confirmed to have been sane, with weakening leading economic indicators and tightening credit, then the recession pain begins.


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