Are fears of a coming recession justified?

With Alex Surmacz

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The business pages are currently dominated by fears of a looming recession. Are these concerns grounded? Or, are the warnings of so many market experts simply baseless attempts to pile criticism on Trump?

A variety of metrics are used to predict recession. One of the most common is the yield curve on U.S. Treasury bonds.

A bond’s “yield” is simply the interest rate the government promises to pay on its debt. The “yield curve” cited in many recent headlines is typically the difference between the rates on long-term (e.g. 10-year) loans and short-term (2-year) loans.

The U.S. government usually promises higher yields on long-term debt. This is because the lender forgoes other opportunities to grow wealth and because there is potentially a higher risk associated with long-term repayment. By contrast, yields are typically lower on short-term debt instruments.

How does this relate to a recession?

Observers generally get nervous when they see something called a “yield curve inversion.” Inversion means that short-term yields are larger than long-term. This is often interpreted as a sign of low confidence, sometimes brought on by a slowdown in growth.

Thirty YEars of YieldS, Four Inversions

 
Yield curve is calculated as 30-year rate minus 2-year rate on US Treasury bonds.

Yield curve is calculated as 30-year rate minus 2-year rate on US Treasury bonds.

 

The yield curve has only inverted three times in the past 30 years. A recession followed each time. This includes 2001 and the Great Recession spanning 2007-2009.

That’s partly why folks are worried now. The curve inverted in 2019 – albeit briefly. According to this single metric, the U.S. is on the verge of a recession.

Inversions beget recessions?

 
Yield curve inversion before 2001 recession. 30-year rate minus 2-year rate.

Yield curve inversion before 2001 recession. 30-year rate minus 2-year rate.

Yield curve inversion before 2007-09 recession. 30-year rate minus 2-year rate.

Yield curve inversion before 2007-09 recession. 30-year rate minus 2-year rate.

Yield curve in 2019. 30-year rate minus 2-year rate.

Yield curve in 2019. 30-year rate minus 2-year rate.

 

Of course, the yield curve is only one measure. And the inversion in 2019 was modest and short-lived. However, it’s understandable that it makes people nervous. Escalating trade tensions and greater uncertainty on Wall Street have many commentators fearing the worst.