Is The Yield Curve Flashing A False Recession Warning? More Economists Are Starting To Think So


For months, the widely (and nervously) tracked yield curve has been inverted in a telltale sign of a looming recession, but in recent days, economists, including one who pioneered the indicator’s model, have signaled that perhaps the current inversion may be a head fake, particularly since the labor market and consumer spending remain strong enough to bolster the economy.

Key Facts

Yield curve inversions have preceded each of the past eight recessions and happen when long-term Treasury yields fall below shorter-term returns, suggesting investors are more bearish about the future than the near term and thereby signaling that the economy is headed toward a downturn.

The current inversion started in June and has recently steepened to the worst degree since the 1980s amid prolonged inflation and growing fears over the economy—indicating that a recession is “almost a certainty,” LPL Financial analyst Lawrence Gillum said in emailed comments on Wednesday.

However, Gillum says a recession “is no sure thing,” positing the odds of one this year are “roughly a coin toss” and noting two main factors “complicating” the yield curve’s current signal: one of the Federal Reserve’s most aggressive tightening campaigns in history driving up short-term rates and expectations of lower inflation pushing down longer-term yields.

Though he notes the yield curve inversion has thus far been a “fairly reliable recession signal,” Gillum says strong consumer spending and a resilient labor market could make this time different, and he points out there has been a “false signal” in the past—an inversion that preceded a credit crunch and manufacturing slowdown in 1967, but not a recession.

Gillum isn’t alone in his skepticism: Over the past week, Duke University economist Campbell Harvey, who led pioneering yield curve research revealed in 1986, has outlined reasons he believes the current inversion is flashing a false signal for the first time in nearly 60 years, including strength in the labor market that could help laid-off workers find new jobs quickly.

“This model is very simple, and there are other things going on in the economy,” Harvey said on CNBC Monday, calling the Fed “a real wild card,” since it drove up short-term interest rates to help slow the economy but could ease policy quickly enough to avoid a recession.

Crucial Quote

“Economic models help simplify a complex world, but it’s important to remember that the signal isn’t always accurate and sometimes things are, in fact, different,” says Gillum. “According to the [yield curve] signal, the probability of a recession is greater than before the global financial crisis, the dot-com bubble and the Covid slowdown. We think that may be overstated.”

Key Background

Several Wall Street firms, including Bank of America and Deutsche Bank, believe the U.S. will face at least a mild recession this year, and on Tuesday, the World Bank warned the global economy is “perilously close” to a downturn. However, some experts have become more optimistic in recent days. On Tuesday, JPMorgan chief Jamie Dimon told Fox Business he remains cautious about speculation that the economy could face a “mild recession,” but he also said the U.S. could ultimately skirt one, with both companies and consumers “still strong . . . and in good shape.” The billionaire also walked back comments made last summer about an impending “economic hurricane,” saying instead that “it could be nothing,” and that “early storm clouds already hit,” with the stock market falling 20% last year and inflation lingering longer than expected.

Surprising Fact

Over the past 60 years, the typical delay between the yield curve first inverting and the beginning of a recession has ranged from 6 to 24 months.

Further Reading

Global Economy Is ‘Perilously Close’ To Recession In 2023, World Bank Warns (Forbes)

What To Know About The Yield Curve—And Why It May Predict A Recession (Forbes)

Fed Expects No Interest Rate Cuts In 2023 (Forbes)