What is a yield curve inversion? If someone borrows money from you, the length of time until he repays you should be the one that determines how much interest you will charge. The longer it takes for your money to be returned, the higher the interest rate, because the greater the risk you carry as a lender. For example, a 30-year mortgage will have a higher interest rate than a 15-year mortgage. That’s common sense.
However, this relationship between time and yield is sometimes broken and a phenomenon called “yield curve reversal” occurs when long-term bonds give lower returns than short-term ones. Simply put, when short-term yields are higher than long-term yields, the market says: The good ones are here … but bad times are coming. “The uncertainty causes investors to prefer a lower return but over time and the long-term returns fall below those for a short time.
Typically, when discussing the reverse yield curve, 10-year treasury bonds are compared to two-year bonds. The two-year and 10-year government bonds flipped slightly at the end of last April but returned to normal shortly thereafter. As of the time of writing, the two-year yields are no higher than 10 years, but earlier today in early trading the yields were briefly reversed again, and once again returned to a flat state.
At the same time, many commentators have suggested reasons why the yield curve reversal does not really indicate a near recession today. Among the reasons, the unemployment rate is 3.6% and consumer spending accounts for 70% of the US economy, which indicates economic resilience, so we currently lack a key component in a recessionary environment.
In addition, yields are now uniform (equal over bond dates) rather than reverse. Although they have been reversed for a short time, the yield curve is fairly flat along the entire curve so it is not a sign of a recession. A recession occurs.Temporary reversals as in the present case had a limited predictive value.
Federal Reserve Chairman Jerome Powell recently disagreed on the predictive nature of reverse interest rates. He argued that the Federal Reserve has studies suggesting that the first 18 months of the yield curve (comparing interest rates of 30, 60, 90 days, etc. ) Are more effective recession forecasters.
A recession is hard to predict. Typically, the economy is in recession for several months before the consensus and economists approve it. In fact, it could be argued that we are already in the midst of a recession. U.S. financial growth (as measured by gross domestic product) was down 1.4% in the first quarter of 2022. The S&P 500 was down nearly 20% from January, and if second-quarter data shows a second-quarter decline, growth criteria could be argued to have been met. It is important to note that a modest recession is not an indication that the stock market is in a sharply lower direction relative to current levels.
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