What is the “inverted” yield curve? According to a recent New York Times article by Matt Phillips, it’s “a powerful signal of recession” and “has Wall Street’s attention.”
Hyperbolic nonsense or useful predictor of the future? Let’s take a closer look.
The NYT article accurately defines the yield curve as the difference between short-term interest rates, like a six-month Treasury bill, and long-term rates, like a 30-year Treasury bond. The slope of the curve reveals clues about the health of the economy, interest rate policy at the Federal Reserve Bank, and bond investors’ expectations for future inflation and economic growth.
The article states “the so-called yield curve is perilously close to predicting a recession and it’s become a big topic on Wall Street.” As a close follower of the financial press, numerous periodicals and various research reports on fixed-income markets, that’s news to me. Economic data remain strong by nearly every measure.
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The current yield curve is positive, meaning short-term interest rates remain lower than long-term interest rates. This is called a “normal” curve that travels up and to the right when you see it depicted on a graph. Granted, the curve right now is very “flat,” with smaller than average differences in yield between short- and long-term interest rates.
This could be explained by low expectations for future economic growth of the U.S economy, low expectations for future inflation, or small increases in consumer prices. Rates remain very low in Europe when compared to the U.S. Prime Rate of about 5 percent. And bond indexes are generally down in 2018 year to date, and we might see negative returns on bonds for the first time since 1982.
The U.S. consumer and government continue to feast on low-cost debt, hitting new records of $13 trillion and $21 trillion, respectively. The Fed finally achieved its stated goal of 2 percent inflation, but will be watching closely for an overheated economy.
Headlines in The New York Times certainly grab your attention — or, worse, might cause you to throw out your long-term planning. But fear not, faithful reader! The economic data do not support this thesis — at least not yet.
Mark Daly is an investment management analyst and partner in the Perpetua Group. Mark@ThePerpetuaGroup.com.