Reader Eric is curious about yield curve inversions. He writes …
Hi Mish
I’ve been a loyal reader for many years. Regarding the yield curve
inversion, which pair is the best, most reliable indicator of a recession? As
you mentioned in your post there was an inversion between the 6 months and 1
year, but short term fluctuations can create temporary graphical anomalies. Is
the bedrock of the inverted yield curve the 1-year to 10-year spread?
Thanks.
Eric
Eric is inquiring about my post Yield Curve Inversion Coming Up?
An inversion occurs when shorter term rates have a higher yield than
longer dated rates. Typically this is a strong recession warning.
The 2-10
spread was always considered a classic spread to watch, and the St. Louis
Fed has a predefined chart. But I expect the next recession to hit before the
yield curve inverts.
Why? Because yields at the short end of the curve are simply too close to
zero for the curve to invert. Discard any notions that a yield curve must
invert before a recession.
2-Year to 10-Year Spread
The 2-10 spread is +81 basis points. That’ gap will not Not going to close
unless the Fed hikes at least twice.
Short duration differences such as 3-month to 6-month have been extremely
noisy. Even the 1-month to 1-year is noisy.
Here are a couple of charts I created that do provide a reasonable basis
for discussion.
Please note the vertical scales on each chart are dramatically different.
1-Year to 2-Year Spread
That looks pretty prone to some false signals.
2-Year to 3-Year Spread
The 2-3 and 2-10 charts are very similar in appearance. Neither had the
1995 head fake of the 1-2 spread.
I am keeping a close watch on the 2-3 spread. It could easily invert on
even a single hike.
The 2-10 spread is +81 basis points while the 2-3 spread is a mere +12
basis points.
Canada Inversion and Recession
When Canada’s Central Bank unexpectedly cut rates on January 21, 2015 the
Canadian yield curve immediately inverted out to three years as noted in may
post Canada in Recession, US Will Follow in 2015.
Canada did indeed go into recession as noted on September 2, 2015 in Canada in Recession with Two Consecutive Quarters of Negative
Growth.
Us Recession?
My call for a US recession has still not come to life. Given massive
backward revisions to GDP it would not surprise me in the least if we are in
one now.
This will cause so some to make “stopped clock” comments.
However, economists have never predicted a recession in advance. Never!
Most do not think we are in one after they arrive.
Bernanke did not think we were in one in 2007 when it hit. Nor did the
ECRI.
The ECRI and I both thought there was a recession near the taper tantrum
that never came about. But it’s possible a very mild recession did hit or was
narrowly averted.
For discussion readers may wish to consider the AEIdeas article Did the Fed’s QE bond buying prevent a deep 2013 recession in
the US?.
The Fed may have prevented a recession, but at the expense of creating a
massive stock market bubble.
At what point does this all collapse anyway?
Mike “Mish” Shedlock