To answer this question, La Presse called on Daren King, economist and financial analyst in the Economics and Strategy Department at National Bank Financial Markets in Montreal.
From the outset, Daren King recalls that “the yield curve is not usually inverted, with short-term rates lower than long-term rates”.
For what ? The basic explanation stems from the functioning of the market for credit and financing products.
“Essentially, when a lender lends money to someone or a business for a short term, the risk of default is usually less risky than when lending over a ten-year period. says King.
“That’s why lenders usually charge a higher interest rate on a ten-year loan than on a short-term one-year loan. »
However, notes Daren King like the reader of La Presse, “we are now in an unusual situation where the yield curve is inverted, that is to say that short-term interest rates exceed interest rates long-term “.
An unusual situation, certainly, but not unprecedented, specifies the economist of the National Bank.
“It has happened a few times in recent decades, contrary to your reader’s observation. Among other things, we saw an episode of an inversion of the yield curve just before the pandemic, at the end of 2019, recalls Daren King.
“Previously, it happened just before the financial crisis in 2008 and the recession that followed. It also happened in the early 2000s after the bursting of the techno bubble in the financial markets and its negative impact on the economy. »
Why do these episodes occur?
“Besides, when we prepare economic forecasting models, we use the interest rate curve among the indicators that can help us see if the economy is going into recession or not. »
In this context, does the recent inversion of the yield curve herald a coming recession?
Daren King points out that this time around, the inversion of the yield curve is mainly the result of recent decisions by the Bank of Canada to raise its key rate sharply, which has pushed short-term interest rates above long-term rates.
“The yield curve has become inverted after a period of historically rapid rate hikes. In just 15 months, the central bank’s policy rate rose from 0.25% in March 2022 to 4.75% in mid-June, King said.
“That’s what makes financial markets think that interest rates are getting too tight, and that they could push the economy into recession. »
That said, at National Bank Financial Markets, what is the prognosis for the next few months?
“In the current context, it becomes certain and certain that a slowdown in the economy is preparing, but without necessarily ending in a real recession, answers Daren King.
“Also, as this slowdown goes on, it will become more and more likely that interest rates have bottomed out and are starting to come down again. »
