What is the yield curve, and what can this 'powerful signal of recessions’ tell us?
It has predicted every recession in the last 60 years, and things are looking kind of scary. So is a recession due in 2018?
Economists are raising an eyebrow because a near-perfect predictor of recessions is flashing a red alert.
"The so-called yield curve is perilously close to predicting a recession — something it has done before with surprising accuracy — and it’s become a big topic on Wall Street," writes Matt Phillips in the "New York Times."
The yield curve is the difference between interest rates on short-term U.S. government bonds and long-term government bonds.
In a healthy economy, the interest rates on short-term bonds are higher than the rates on long-term bonds. It staves off inflation. What has financial types reaching for the Maalox is that the interest rates on long-term bonds aren't rising, so the gap between short-term and long-term is closing.
That yield curve is now 0.34 percentage points. "It was last at these levels in 2007 when the United States economy was heading into what was arguably the worst recession in almost 80 years," says Phillips.
When interest rates on long-term bonds rise above short-term bonds, the yield curve has "inverted." An inversion is “a powerful signal of recessions,” the president of the New York Fed, John Williams, said this year.
What's more: Every recession in the past 60 years has been preceded by an inverted curve. The only "false positive" came in the 1960s, and that was the signal of an economic slowdown, not a full-blown recession, Phillips writes.
So is a recession coming? Surely not, right? Employment is at record highs, wages are rising (albeit at a snail's pace), inflation is stable. Economists say all the indicators are good.
(Well, except for the yield curve, the one that seems to matter most of all.)
The fact is that we're well overdue for a recession — defined as two consecutive quarters of negative GDP growth — which tends to happen every seven or eight years. It's been almost 10 since the last one. "A recession is likely sometime between now and 2019," wrote George Friedman on MarketWatch in May 2017. "We are eight years from the last recession, and 10 years has been the longest period between recessions. The precursors to a depression — such as irrational exuberance of asset classes, rising interest rates, a negative yield curve, and proclamations that 'this time, it’s different' — have at most been modestly appearing. But the clock is ticking."