The yield curve inversion and what that means for the economy
The bond market has driven the 3-month yield higher than the 10-year yield (the classic “yield-curve inversion”), which has been a recession indicator for the past 60 years. This should be a concern for stock market investors, as recessions are usually very bad for the stock market. However, as of late, the stock market seems to have taken the yield curve inversion in stride. What then, should we expect for the overall economy?
Historically, the yield curve inversion always indicates a coming slow-down of the economy, and almost always precedes a recession (only one exception in the 60-year period described above). The global economy has already slowed, as is the case for China and Europe, and challenges to growth in the US continue as a result of tariffs and the on-going trade wars between the US and our trading partners. It comes down to the US consumer, which is currently keeping our economy going, but how resilient will consumers be to the next market downturn?
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Reserve Bank of Cleveland maintains a yield curve predicted GDP growth metric on its website, which provide both a historical reference and a GDP projection.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 indicates that the yield curve is approaching the zero axis, and when it crosses that axis - you have the definition of a yield curve inversion. Since the yield curve is now inverted, what does that mean for the economy?
The Cleveland Fed also has a recession probability graph on the same website, which is calculated from the yield curve. The below graphic (from that website) shows the probability of a recession by 2020 is now 30%. It is interesting to note from the graphic that, in only one instance in the past 40 years has the probability risen that high without an immediate or ongoing recession.