Yield curve disinversion is the recession signal to watch: Jaime Mcgeever

The pandemic has challenged economic norms, particularly the inverted U.S. yield curve, which traditionally forecasts recession. However, delayed impacts of monetary policy changes and pandemic stimulus complicate predictions. Economic resilience defies conventional wisdom..Sign up for your early morning brew of the BizNews Insider to keep you up to speed with the content that matters. The newsletter will land in your inbox at 5:30am weekdays. Register here..By Jaime Mcgeever*.Of all the economic rules of thumb the COVID-19 pandemic seemingly ripped up, few have caused as much soul-searching as the inverted U.S. yield curve – though it may just be interpreted incorrectly. .___STEADY_PAYWALL___.After almost two years of short-term interest rates topping long-term yields, the recession that it traditionally presages still hasn't shown up..Whether it's the difference between three-month and 10-year yields, or two-year and 10-year yields, the downward sloping yield curve has now been in place for the longest stretch on record..Every one of the last eight U.S. recessions going back to the 1960s has come after the three-month yield has fallen below the 10-year yield. All six recessions going back to the mid-1970s, when the two-year/10-year yield curve can first be traced, have also followed inversion..But the problem is timing the turn. In the 19 months since the 3-month/10-year curve and 23 months since the "2s/10s" curve last inverted, respectively, recession is still nowhere to be seen and there is very little sign of it on the horizon..Not only has recession not reared its head, the economy has barely flinched in the face of both the highest inflation and most aggressive Fed rate-hiking cycle in 40 years. The comfort blanket of historical accuracy is steadily being removed..But if investors and economists think they got a bum steer in expecting a recession after the curve first inverted, they should perhaps have put more weight on the fact the curve disinverts just before the recession actually hits..Jim Bianco, president and macro strategist at Bianco Research, notes the average time to recession from the 3-month/10-year curve first inverting is 334 days, but only 66 days from when the curve disinverts..Crucially, in each of the past eight recessions that "uninversion" of the curve has been the result of a "bull steepening" where short-dated yields have tumbled as the Federal Reserve has cut rates in the face of very obvious economic or market stress..Once the U.S. central bank starts cutting rates and the curve "bull steepens," recession is much closer at hand.."The yield curve doesn't normalize until something changes in a big way – serious signs of the economy slowing, a geopolitical shock like 9/11, a housing market crash, or stock market bubble bursting," Bianco says.."It's panic that makes short rates fall and the curve bull steepen. "We're nowhere near uninverting the curve right now," he adds..WARNING SIGNS FLASHING.A "bear steepening" of the curve, where serious fiscal or inflation concerns trigger a steep rise in long yields, would raise other issues. This is less likely but cannot be completely ruled out..If an inverted curve was the harbinger of imminent recession that people thought it was, a record long period of inversion would surely not have been accompanied by record high equities, the tightest credit spreads in years, and historically low volatility in stocks and currencies..When the yield curve steepens and slopes normally again, will these market dynamics hold up? In a counter-intuitive way, a persistently inverted curve suggests the economy is in decent shape and the Fed doesn't need to slash rates..U.S. rates futures markets, at least, have almost completely given up on rate cut bets. In January, more than 150 basis points of Fed easing was priced into the 2024 curve – that is now just 35 bps..For many, an inverted yield curve doesn't say anything about growth per se, rather it predicts a downward-sloping inflation curve. But for a Fed determined to get inflation back down to its 2% target, weak growth or worse might be the price it has to pay..Economic warning signs certainly are flashing. Factory activity is shrinking, consumer demand is softening, the U.S. economic surprises index is deeply negative, and some closely-watched GDP growth trackers are being revised down..Ultimately, however, the economy's remarkable resilience in the face of 525 basis points of Fed tightening between March 2022 and July 2023 shows it is far less sensitive to interest rates than it once was..Milton Friedman's famous "long and variable" lags between monetary policy changes and their economic impact are longer than they used to be. Technology, the dominance of services and fundamental changes in labor markets are key reasons..Add to that the trillions of dollars of pandemic-fighting monetary and fiscal stimulus pumped into the economy, says Troy Ludtka, senior U.S. economist at SMBC Nikko Securities Americas.."The U.S. economy emerged from the pandemic with a ton of momentum. The yield curve hasn't lost its potency, the effects are just delayed," Ludtka says, adding that an inverted curve helps cause recessions because it is harder for financial institutions to make money, so they reduce lending..Another rule of thumb that Ludtka says still stands is that for every 1 percentage point GDP growth is below potential, the unemployment rate rises half a percentage point. The jobless rate could easily rise by that amount this year, he says..Upcoming jobs data will be crucial. Slumping payrolls growth and spiking unemployment will likely fuel recession talk, rate cut bets and yield curve "uninversion" trades..On the other hand, a strong jobs report on Friday could effectively wipe out the last remaining quarter-percentage-point rate cut priced in for this year, pushing a steeper yield curve even further into the distance..Read also:.🔒 The HPV vaccine is just as important for boys as it is girls: Lisa Jarvis🔒 "Unity" government proposal – is it on the table?Invest or pay tax – Section 12B Solar.*(The opinions expressed here are those of the author, a columnist for Reuters.).SOURCE: REUTERS

Yield curve disinversion is the recession signal to watch: Jaime Mcgeever

Related Stories

Econ Bro: Special Economic Zones and how they expose the hypocrisy of the state

Econ Bro: How SEZ's expose the hypocrisy of the State

Magnus Heystek: Why I (and my clients) still prefer offshore investments

Ruchir Sharma: How America's retail investors came to rule Wall Street