What Happens When An Indicator Just… Breaks?

by | Jun 3, 2024

Wall Street’s go-to signal for predicting recessions, the inverted yield curve, is raising eyebrows.

The so-called yield curve inversion, where short-term Treasury yields surpass long-term ones, has historically signaled an impending economic downturn. It’s been 100% accurate for the past eight U.S. recessions.

But this time, things are different.

The yield curve has been inverted for a record stretch of about 400 trading sessions — yet the economy hasn’t slowed down significantly.

In fact, recent data shows that U.S. employers added 175,000 jobs last month, and economic growth is expected to pick up this quarter.

Traditionally, an inverted yield curve signals that investors expect the Federal Reserve to cut interest rates to stimulate a faltering economy. But despite the current inversion, the anticipated recession hasn’t shown up.

Some experts suggest that a recession might just be delayed this time.

The yield curve’s track record as a recession predictor is impressive. It gained prominence thanks to Campbell Harvey’s 1986 dissertation, which highlighted the connection between inverted curves and economic downturns.

But recent years have been unusual, and some believe the pandemic has disrupted long-standing economic patterns.

What Happens When An Indicator Breaks?


So, what happens when a trusted indicator like the yield curve just… breaks?

If a recession doesn’t materialize soon, it could do lasting damage to the yield curve’s status as a warning system.

Investors might begin to question its reliability, leading to a shift in how market signals are interpreted.

This could be one of the most significant examples of how the fallout from the Covid-19 pandemic has upended long standing assumptions on Wall Street about how markets and the economy function.

Till now, investors have relied heavily on the yield curve to guide their decisions. But if this indicator fails to predict a recession this time, it might lose its near-mythical status.

This scenario forces us to consider: Can a single measure from the bond market still forecast the complex U.S. economy, or do we need a more nuanced approach?

The current scenario raises questions about the yield curve’s reliability. While it still indicates investor expectations for rate cuts, these expectations may now reflect a more complex economic outlook.

For example, the Fed’s aggressive rate hikes in the 1980s aimed to combat inflation, not prevent a recession.

Similarly, external shocks like oil price surges and the pandemic have influenced past recessions.

Despite some weaker economic reports, the yield curve remains inverted.

This has become the new normal for many investors.

The next few months will be crucial in determining whether this trusted recession indicator is still accurate or if it’s time to rethink its significance.

Stay tuned as we navigate these uncertain times, and remember to keep a balanced perspective on market signals.

— The Jeffry Turnmire Trading Team


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