August 22, 2019

The Recession on the Horizon

“If you believe the signals coming out of the bond market, it might be time to start counting down until our next recession.

As of this week, the U.S. Treasury yield curve has now been inverted for a full quarter—an incredibly dull-sounding turn of events that happens to be an unusually reliable warning sign that an economic downturn is on the way. The yield curve has flipped prior to each of the last seven official recessions over the past 50 years, without a single false-alarm during that stretch. If securities could talk, in other words, they’d be screaming bloody murder about trouble ahead.

When finance types say that the yield curve is “inverted,” what they really mean is that the typical order of the debt markets that prevails when the economy is healthy has been turned on its head. Usually, long-term U.S. government bonds offer higher yields than short-term ones, because buyers demand higher interest rates in return for locking up their money for greater periods of time. There are a few reasons why this is the case, but a big one is that the longer it takes to get repaid, the more risk there is that inflation will eat up your investment.

When the yield curve is inverted, however, the opposite becomes true: The returns on long-term bonds dip below returns on short-term ones. Again, there are many reasons that this could happen, but it’s generally interpreted as a sign that the market expects weak or nonexistent growth in the coming years, and very little inflation.”

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