This Inverted Yield Curve Is Not Forecasting A Recession

Historical charts show inverted yield curves often precede recessions. Therefore, many conclude that today’s inverted yield curve means a recession is coming.

The problem is, that link is a sloppy indicator. Sometimes it far predates a recession, and sometimes it simply returns to a normal upslope without a subsequent recession. The current one falls into a unique category. Three forces are at work:

• First, the Federal Reserve’s inflation fighting involves interest rate raising. (That contrasts to the more typical money tightening done to cool a rapidly growing economy.) Hence, the short-term rates (the ones controlled by the Fed) have risen.
• Second, Wall Street is attempting to forecast the Fed’s future actions and resulting inflation effects. The inversion began when the Fed’s rising rates caused Wall Street to expect reduced inflation, meaning lower interest rates in the future. (Because longer-term rates are a combination of the higher short-term rates and lower future ones, the future ones pulled down the overall rates.)
• Third, the Federal Reserve is correcting a wrong – abnormally low interest rates (below the inflation rates) for fourteen years that penalized savers and rewarded borrowers. And they are still too low. See my recent article…

MORE FROM FORBESC’mon Fed – Stop Calling Negative Real Rates Tightening – You’re Not There YetBy John S. Tobey

Recent shifts in the inversion

There was a recent rise in optimism that turned longer-term rates down, widening the inversion. Expectations had the Fed beginning to cut rates towards the end of this year. However, those thoughts then changed, pushing the Fed’s higher rates out to 2024, causing current longer-term rates to rise.

The following graphs show how the inversion developed and then recently changed.

The bottom line: Simplistic reasoning always loses when investing

In this digital age, we are bombarded with supposed correlation-based “rules” like the one discussed here. The rationales, dreamed up afterwards, are usually flawed, top-of-the-head conjectures. Worse, they are presented as absolute facts, with the media articles spreading the “news” beneath dramatic headlines.

What’s an investor to do? Read, study, analyze and ignore the noise.