History of Recessions Following an Inverted Yield Curve

The history of recessions following an inverted yield curve is a fascinating topic that reveals a concerning pattern in the economy. Since 1955, there have been eight recessions triggered by an inverted yield curve.

An inverted yield curve occurred in 1958, leading to a recession that lasted for 10 months. The curve inverted again in 1960, resulting in a recession that lasted for 4 months.

The 1973 recession was preceded by an inverted yield curve, which lasted for 16 months. The curve inverted again in 1980, leading to a recession that lasted for 6 months.

In 1990, an inverted yield curve occurred, resulting in a recession that lasted for 8 months. The curve inverted again in 2000, leading to a recession that lasted for 8 months.

The inverted yield curve has a significant impact on the economy. Typically, it precedes recessions, and the spread between 10-year notes and 3-month bills has dropped from -15 bps to -51 bps.

Consumer sentiment suffers greatly during these periods, with the University of Michigan's US Consumer Sentiment Index either declining, below its historical average, or both. The same goes for the US Consumer Price Index, which was either on the rise, above its historical average, or both in all six recessionary periods.

The Consumer Sentiment Index hit an all-time low of 50 last June, right as the 10-2 year spread turned negative and inflation peaked at 9%.

Consumers seeking short-term loans tend to be worse off amidst an inverted yield curve, with interest rates rising and costs of borrowing going up.

The Consumer Sentiment Index hit an all-time low of 50 last June, coinciding with the 10-2 year spread turning negative and inflation peaking at 9%.

Consumers' mood tends to sour in an inverted yield curve environment, which can ultimately force the economy into contraction.

The US Consumer Price Index was on the rise, above its historical average, in all six recessionary periods, and the Consumer Sentiment Index was either declining or below its historical average in all six periods.

Interestingly, the 10 year-3 month spread has remained firmly underwater despite the Consumer Sentiment Index marching optimistically higher.

Companies in the business of short-term borrowing and long-term lending, such as banks, have historically underperformed when the yield curve inverts. Borrowing costs increase near-term, and profits get compressed when long-term loans are issued with less attractive rates.

Stocks bearing high dividend yields are less attractive when short-term rates spike. This is because yield-seeking investors may flee equities in favor of shorter-term treasuries.

Companies that issue short-term loans can expect to see a bump in interest payments when short-term rates rise. Apple and Berkshire Hathaway, two of the largest companies on earth, have historically logged large figures on the Cash and Short-Term Investments lines of their respective balance sheets.

The value of bonds with higher risk, such as junk bonds and corporate bonds, contract when the yield curve inverts. This is because the spreads between lower-risk US treasuries and these higher-risk instruments narrow.

Investors may have an opportunity to achieve a greater effective yield from their cash by locking in a similar interest rate at a lower duration to maturity. However, if short-term rates continue rising, the bond value would likely decrease.

Companies with large amounts of liquid assets can expect to see a greater return on any new short-term investments when short-term rates rise.

This economic cycle is unlike any other, with multiple factors pushing short-term rates higher while having less of an impact on longer-term rates. The Federal Reserve cut its policy rate to near zero in 2020 to minimize the COVID-19 recession's impact.

The Fed needs to play catch up to counter rapid inflation, forecasting a 2.875% rate by the end of 2022, with a possibility of a 75 basis point hike that would push the end-of-year rate to 3.125%. This would be a significant increase from the current rate.

Fed rate hikes usually nudge interest rates for other bonds higher, but the effect isn't always linear. Short-term bond yields are increasing, while yields for longer-term bonds have barely budged.

The risk of recession is a growing concern, with the Treasury yield curve inverting as a weakening of real business activity prompts traders and investors to anticipate a shift in monetary policy to a more accommodative stance. Typically, this is a sign of a recession further out, not a near-term business cycle downturn.

The smoothed U.S. recession probabilities model maintained by Professor Jeremy Piger of the University of Oregon placed the probability that the U.S. economy was in recession in July 2019 at just 1.5%. However, the Federal Reserve Bank of New York's model put the chances that the economy will be in a recession in August 2020 at 37.9%, well above the 31.7% average prevailing ahead of the last three cyclical downturns.

A near-term business cycle downturn appears remote, but the inverted Treasury yield curve has raised fears of a recession further out. The attractiveness of investing in a steadily appreciating currency cannot be overlooked, especially with the U.S. currently sporting the highest interest rates across the Group of Seven and Switzerland.

The yield curve has merely inverted by a handful of basis points thus far, which doesn't invalidate the signal altogether, but it means the signal is at the faint end of the spectrum and could well vanish with only a slight recalibration of the bond market. In the past, this has been a strong indication that investors collectively see more risk in the immediate future than down the road.

The bond market lacks a term premium, which normally keeps the longer end of the yield curve elevated until the outlook is truly dire. Without this premium, the yield curve needs to invert more significantly than normal to furnish the same signal, making it a muddier investment environment than usual.

The probability of a U.S. recession is about 35 percent for 2019 and 40 percent for 2020, according to RBC Global Asset Management. This view was once considered pessimistic, but is now interpreted as on-consensus or even optimistic relative to some market views and the output of formal recession models.

The inverted yield curve has been a strong indicator of impending recession in the past, but it's essential to understand what it means and how to prepare for it.

In the past, an inverted yield curve has been a strong signal of a recession within the next 12-18 months, with a 37.9% chance of recession in August 2020, according to the Federal Reserve Bank of New York's model.

We need to be mindful of the impact that weaker economic activity abroad may have on the Treasury yield curve, as the US currently sports the highest interest rates across the Group of Seven and Switzerland.

The attractiveness of investing in a steadily appreciating currency cannot be overlooked, and this may contribute to the inversion of the yield curve.

In reality, yield curves flatten for a multitude of reasons, most of which aren't a reflection of investor views about slowing growth, as Matthew Hornbach, Global Head of Macro Strategy for Morgan Stanley, points out.

It's essential to be prepared for a potential recession, and understanding the inverted yield curve is a crucial step in doing so.

The Treasury yield curve has inverted, raising fears of an impending recession. This typically happens when investors expect a shift in monetary policy to a more accommodative stance.

The spread between 10-year notes and 3-month bills initially inverted at the end of May, and since then, it has dropped from -15 bps to -51 bps. This has raised concerns about a recession further out.

The smoothed U.S. recession probabilities model maintained by Professor Jeremy Piger of the University of Oregon puts the probability that the U.S. economy will be in a recession in August 2020 at 37.9%. This is well above the 31.7% average prevailing ahead of the last three cyclical downturns.

The U.S. currently sports the highest interest rates across the Group of Seven and Switzerland. In four of the eight countries – France, Germany, Japan, and Switzerland – yields at key maturities are all below zero.

The attractiveness of investing in a steadily appreciating currency cannot be overlooked. This is a factor to consider when looking at the impact of weaker economic activity abroad on the Treasury yield curve.

To stay ahead of the curve, you can track the 10-2 year, 10 year-3 month, and 30-10 year spread indicators in YCharts. This can help you identify which fixed income instruments are headed for inversion.

The Canadian yield curve is currently inverted, featuring durations as short as the Canadian 1-Month Treasury Bill all the way up to the 10-Year Benchmark Bond. This is a sign to watch as we prepare for potential recession.

The yield curve has inverted by only a handful of basis points, making it a faint signal that could easily vanish with a slight change in the bond market.

This subtle inversion shouldn't be taken as a reason to panic, as it's a relatively minor development.

While an inverted yield curve is a valid reason for caution, it's essential to consider the bigger picture.