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Recession Early Warning? US Yield Curve Inverts

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Peter Schiff has said a recession is a done deal. Since he made that comment, we’ve seen more and more signs of a looming economic downturn.  On Friday, we got another. The yield curve inverted, historically a sign of a looming recession.

The yield on 10-year Treasurys fell below the yield on 3-year bonds for the first time since 2007 – the cusp of the Great Recession.

Global bond yields actually inverted last summer. At the time, the Financial Times called a yield curve inversion “Coco Chanel’s proverbial ‘little black dress’ of economic indicators.”

The slope made up of bond yields of various maturities has a record of predicting recessions that would make even the savviest econometrician turn pea-green with envy. It is not perfect, but the curve has become flat and inverted — when short-term bond yields are actually higher than long-term ones — ahead of most economic downturns in most major countries since the second world war.”

According to the New York Times, yield curve inversions have accurately predicted all nine economic recessions since 1955. There was one false positive in the mid-1960s when an inversion was followed by an economic slowdown that did not dip into 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 3-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 tends to fall. That puts downward pressure on long-term yields. The difference between long-term and short-term yields flattens and eventually inverts.

Duke University finance professor Campbell Harvey told NPR yield curve inversions are “almost always bad news.”

My indicator has successfully predicted four of the last four recessions, including a pretty important call before the global financial crisis.”

Harvey said he wouldn’t actually predict a recession until the yield curve remains inverted for three months.

Peter has also said that the Powell Pause won’t be enough and that the Federal Reserve’s next move will be to cut interest rates. On Tuesday, Reuters reported, “Fed rate cut seen nearer as yield curves invert.”

The Federal Reserve’s stunning about-face on rate increases along with weak economic data has left a key part of the US Treasury yield curve close to levels at which the US central bank has in the past been prompted to cut rates.”

Even with the yield curve inversion, many mainstream analysts remain convinced that the US economy is “strong.” Goldman Sachs advised against “panic” in light of the inversion, noting that the proportion of the yield curve that is inverted isn’t as high as in past recessions and the yield on the 2-year remains above the yield on the 10-year. A Goldman strategist wrote that the “recession risk remains somewhat low.”

Of course, it takes a lot to get the mainstream off its bullish narrative. Even as it does a complete 180 on monetary policy, the central bankers at the Fed keep insisting the US economy is great. This prompted Peter to recently say, “I don’t think I’ve ever seen people more clueless.”

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