An inverted yield curve is often discussed, but is also an often-misunderstood indicator.
The point behind an inverted yield curve remains true: the curve inverts in one of two ways. The first way is when the Federal Reserve has raised short term rates as a way to curb inflation in a faster-than-normal growing economy.
The second way a yield curve can invert is when there is little to no fear in the marketplace (or economy). When this happens, you see investors piling into the longer term maturities. This does not happen often (and if it does occur, is usually temporary/perhaps even momentary).
When there is great fear in the economy or market, investors will flee from the risk investments (stocks) into “safer” investments (short term bonds). More buyers in the short end will cause yields to fall.
One of the readily accepted indicators for inversion is the measure between the yield on the two-year Treasury versus the ten-year Treasury. This is also referred to as the 2/10 spread. When the yield on the two year exceeds the yield on the ten year Treasury, the short term yields are higher.
It’s Different This Time
Now, one of my big red flags is when folks state “it’s different this time!”
Because it’s usually not different this time. So my cringe-factor increased exponentially when I read this on Bloomberg:
An inverted Treasury yield curve is no longer a reliable signal of recession, and what matters more is the level of the curve, Bank of America economists Ethan Harris and Aditya Bhave said in a note.
You can read the full post here.
Translation: it’s different this time.
But is it different the time? The inverted yield curve foretells an upcoming recession six months, nine months, and sometimes a year (or more) in advance. How can these folks KNOW this is “no longer a reliable signal”? The yield curve only recently inverted on March 22, 2019 (and quickly reversed itself).
Not saying an “inverted yield curve” is accurate or not. I am wondering how can the Bank of America economists can know it’s losing effectiveness?