In this Goldilocks economy of low inflation, low unemployment, and good GDP growth, what could go wrong?
Federal Reserve Chairman Jerome Powell stated in a speech in Boston that we are in “extraordinary times.” The Fed believes that this period of low inflation and low unemployment, in contradiction with the Phillips Law of economics, could continue into the next decade. This projection allows the Fed to maintain its course of steady interest rate adjustments (a process they call “normalization”) through 2019 and possibly 2020.
However, by continuing this path of “normalization,” the Fed risks triggering another rule in economics, called the “yield curve inversion.” The yield curve inversion is when short term interest rates, which are usually the lowest rate because of the lower term of repayment (hence lower risk), become higher than longer term interest rates. The usual outcome of a yield curve inversion is a recession, and so the yield curve has become a recession predictor.
The Federal Reserve Bank of Cleveland maintains a yield curve predicted GDP growth metric on its website, which provide both a historical reference and a GDP projection. This curve shown below indicates that the yield curve is approaching the zero axis and could turn negative in the near future (the definition of yield curve inversion). So, the question is: how long will it be before a yield curve inversion and the next recession?