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Peter Schiff Talks Yield Curves, Inflation and the Looming Recession

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Last month, we reported that the global yield curve inverted, signaling the possibility of a looming recession. While narrowing to levels not seen since right before the 2008 financial crisis, the yield curve has not inverted in the US. In his most recent podcast, Peter Schiff said he doesn’t think it’s going to happen. He said we may even see a steepening yield curve in the coming months. But this is not because there’s not going to be a recession.

In general, investors demand a higher rate of return for locking their money up in long-term bonds and yield curves normally slope upward. The rate of return on a 2-year bond will typically be less than the return on a 10-year bond. During economic expansions, inflation expectations tend to rise. As a result, investors demand even higher yields for long-term bonds to offset this effect. A sharply upward-sloping yield curve generally means investors have optimistic expectations for the future. But during recessions, inflation expectations tend to fall. That puts downward pressure on long-term yields. The difference between long-term and short-term yields flattens and eventually inverts.

Yield curve inversions have signaled all nine recessions since 1955. But Peter doesn’t think the curve will invert before the next downturn because the dynamics in the economy are different. In fact, he thinks long-term interest rates will actually rise and the yield curve will steepen as we go into recession.

Typically in a recession, or at least the post-war experience in these boom and bust cycles that the central bank has created, normally, they are well-further in advance in their tightening cycle at this point in an expansion. You know, we are already 30% larger than average, or longer than the average expansion. We’re less than a year form this being technically the largest expansion in history. Yet the Fed has only managed to raise interest rates to 2%. Normally at this point, we’d be well north of 5% and so it’s a lot easier to invert the yield curve when you’ve got short-term yields up above 5%. And normally, the Fed is trying to fight off inflation, and that’s one of the reasons that it’s raising rates. And it is the fact that the Fed is making money more expensive and we’re deeper into the cycle that the long end actually starts to fall anticipating the recession that is going to result from the tighter monetary policy. And so that’s what ends up inverting the yield curve. It’s not that the inversion of the yield curve causes the recession. It’s just that long rates start to fall as investors start to look beyond the expansion to the next recession and they start pricing in the next round of rate cuts.”

As Peter pointed out, the flattening or inversion of the yield curve is merely a signal. You don’t have to have an inverted yield curve to have a recession. Peter said that’s how it will play out this time. We will have a recession without an inversion of the yield curve given how little headway the Fed was able to make in normalizing rates during the expansion.

This time we’re not going to get an inversion of the yield curve, and in fact, I think the long end is going to be rising because of higher inflation and because of waning demand for US Treasuries in the face of exploding supply, especially when we move into recession.”

This dovetails with a question we asked earlier this year: Who is going to buy all of the US governments debt? The US Treasury Department plans to auction off around $1.4 trillion in Treasuries this year. And it won’t end there. The department expects that pace of borrowing to continue over the next several years.

As Pete pointed out, the deficit is already in the stratosphere even without a recession.

I think as the economy relapses into recession, and the Fed has to go back to quantitative easing, the budget deficits are going to completely explode and there’s not going to be demand globally for those dollars.”

That would likely mean falling bond prices and rising yields – i.e. interest rates. Not good news in an economy built on debt.

As a result of all this, Peter thinks the long end will rise even as the Fed suppresses short-term rates.

So what that means is that this yield curve, rather than inverting, is actually going to get steeper and steeper.”

Peter said some people might interpret the steepening curve to signal that there isn’t going to be a recession. He said that would be a big mistake.

Peter also touched on this notion that rising interest rates are good for the dollar and bad for gold.

That is not true. Especially if you look at the reason that rates are rising. And it’s not short-term rates that are rising. It’s long-term rates that are rising. And they’re rising because of higher inflationary premiums being built into the bond market, and because of supply and demand. Too much supply and not enough demand. All of this is bearish for the US economy, which relies on a constant flow of cheap money. So, you make that cheap money less cheap, that is going to undermine the US economy and more inflation is bad for the dollar by definition because the dollar is losing purchasing power, and if your currency is losing purchasing power, it is less valuable. You are less likely to hold the currency if it is losing value. And of course, higher inflation is bullish for gold because gold is an inflation hedge.”

In this podcast, Peter also talks, GDP, tariffs and freedom.


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