Originally written June 15th, 2022:
The notorious inverted yield curve is back, and it’s notorious for a reason.
Rates (measured by yields on U.S. treasury bonds) have risen steadily over the last several months, which we illustrate in this visual of the yield curve floating higher since February. Growing inflation and expectations of a Fed rate hike in response have pushed yields higher in the market for treasuries.
Of particular interest to investors recently has been the inverted yield curve, in which short-term rates (such as the 2-Year and 5-Year treasury yields) move higher than comparable long-term rates (like the 30-Year yield).
A good deal of markets-related chatter suggests that this shape can foretell a recession, but is this concept supported by evidence? The answer is definitely yes, though the yield curve is by no means a perfect predictor of recessions, or the best one (Estrella and Hardouvelis 1991, Estrella and Mishkin 1998).
For example, incorporating backward-looking 1-year total return of the S&P 500 into a forecasting model in addition to the yield curve tends to yield more accurate recession predictions (Liu & Moench 2016).
Do you think we are headed for a recession? Is the yield curve a reliable indicator of this risk?
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