(New York) For the past year, a red light announcing a recession has been flashing on Wall Street. But some investors believe that this is a false alarm and that the Federal Reserve will be able to control inflation without a deep economic slowdown.
This red flag, the “yield curve”, remained visible in 2023; recently it has an intensity not seen since the early 1980s. Yet, despite this ominous omen, the stock market has recovered and the economy remains strong; so some analysts and investors are wondering about the predictive value of this signal.
On Wednesday, the June consumer price index showed a sharp slowdown in inflation, boosting investor optimism and pushing stocks further higher.
The yield curve shows the difference between the yield of US federal bonds of different maturities. As a general rule, investors require more interest to lend long-term, so these yields are usually higher than those of short-term bonds. On a graph, it gives an ascending curve. Over the past year, the curve has inverted: the yield on short-term bonds is higher than that on long-term bonds.
However, the US economy is slowing, but remains robust, even after a substantial rate hike.
“This time around, I’m inclined to put less emphasis on the yield curve,” says Subadra Rajappa, interest rate analyst at Societe Generale.
One common measure of the yield curve has reached 40-year highs this year: the yield on two-year bonds is about 0.9 percentage points higher than that on 10-year bonds.
We saw such a reversal in the early 1980s, when the Fed was fighting runaway inflation, which led to the recession of 1981-82.
It is difficult to predict the time between an inversion of the yield curve and a recession, and this time varies widely. Nevertheless, for five decades, it has been a reliable indicator.
Arturo Estrella, one of the first to use the yield curve as a forecasting tool, said this week that inflation generally slows after the onset of a recession, but the rapid pace of rate increases over the past year could upset the normal order.
Others believe it might be different this time around, as current conditions are unprecedented: the economy is recovering from the pandemic, unemployment is low, and businesses and consumers are doing quite well.
“Our current situation is very atypical,” says Bryce Doty, portfolio manager at Sit Investment Associates. “I don’t believe it heralds a recession. It is a relief that inflation is falling. »
