How Does the Treasury Yield Curve Predict Recessions So Accurately?

wouldn't it be great if there was a recession indicator that we could all look to that was so accurate that it had predicted every recession without fail since the 1950s well there is it's called a yield curve inversion and the warning lights for another one are flashing right now i'm going to tell you what the yield curve is and what it means when it inverts why it's been such an accurate predictor of recessions for the last 70 years and why we could be seeing another one soon the us government pays interest to borrow money and that interest rate fluctuates constantly on the open market the longer it takes to be paid back the higher the interest rate at least that's how it works during normal times when the economy is solid so you see what's known as the yield curve the further out in time you go the higher rates are our video team did a full breakdown on bonds the yield curve and yield curve inversions in march 2019. if you want to do a deeper dive in the mechanics check out the link in the comments as the economy struggles you start to see the yield curve take on a different shape and if things don't get better you see the curve in verb a yield curve inversion happens when the interest rates on long-dated treasuries are lower than those on short-dated treasuries when investors see the economy starting to struggle they start to demand higher interest payments on short-term bonds that's because bonds are less likely to be paid back when economies are in trouble and the movement shows that the demand for money now is greater than in the future a sign that the economy is slowing down that tends to be a good signal that a recession is about to happen the yield curve has inverted before every single recession since the 1950s and the federal reserve has even said an inversion is a quote reliable predictor for an economic downturn if you look at a chart showing the difference between the 10-year and 2-year government bond or the 10-year and 3-month bond it goes negative or inverts before every recession researchers at the fed say that's largely because the interest rate on the 10-year note reflects long-term perceptions of the economy while interest rates on the two-year note are largely a reflection of monetary policy when monetary policy is pushing short-term interest rates higher but investor sentiment is falling you can see the yield curve invert now that inversion hasn't happened yet but the market is headed in that direction so far this year we've seen inversions of the 20-year and 30-year bond the five-year and 10-year note and the seven year in tenure the difference between the interest rate on two-year and 10-year notes recently declined to the smallest it's been since 2020 when the u.s had its most recent recession that difference also known as the spread has been compressing pretty consistently for most of 2022 this has been a result of continued high inflation pushing up expectations for the fed to raise rates as well as worsen the economic sentiment and worries about the conflict in ukraine one hopeful caveat for investors and the rest of us who don't want to see a contracting u.s economy is that an inversion doesn't mean an immediate u.s recession the time between an inversion and a recession has varied from 6 to 24 months and stocks typically perform well during that time things could still turn around and the curve might not invert we've seen that before and to be sure an inverted yield curve doesn't cause a recession it's just a warning sign so an inversion doesn't mean a recession has to happen but i'm always skeptical of the four most worrisome words in finance it's different this time if you enjoyed this video hit that like button and subscribe to keep up with my latest videos on markets i'm reminded of the late great biggie smalls who said stay far from timid only make moves when your heart's in it and live the phrase sky's the limit i'll see you next time

Channel: The Wall Street Journal

Views: 27,307

Keywords: yield curve, us treasury, economy, economics, treasury curve, recession, inflation, recession 2022, economic recession, federal reserve, the fed, us interest rates, interest rates, rising interest rates, yield curve inversion, recession explained, recession coming, us government, us govt, bonds, us bonds, bond market, markets, markets news, american economy, short term bonds, economic downturn, government bonds, ukraine, russia, ukraine war, investing, stock market, wsj, wsj news

Id: VPDIgduznFI

Length: 3min 54sec (234 seconds)

Published: Mon Mar 21 2022