Some investors believe the recession warnings that have been flashing on Wall Street over the past few months are false and that the Federal Reserve will be able to keep inflation in check and avoid a deep recession.
Signals known as the yield curve began last year to suggest the economy was headed for a downturn. Since then, however, the stock market has risen and the economy has remained resilient.
A yield curve represents the line created on a chart when the interest rates of government bonds of different maturities are put in chronological order. Typically, investors expect more interest to be paid on long-term loans, forming an upward-sloping curve. Over the past year, the curve has reversed, with short-term yields rising above longer-maturity bond yields.
This reversal suggests that investors expect interest rates to fall from their current highs over time. And that usually only happens when the economy needs support and the Fed decides to help by lowering interest rates.
But with the U.S. economy slowing but still strong and investors expecting good news in Tuesday’s inflation report, the Fed’s attempt to slow inflation has taken hold. is expected to show that
“We tend to be less focused on the yield curve this time around,” said Subhadra Rajappa, rates analyst at Societe Generale.
One common yield curve indicator is that the yield curve has reversed the most in 40 years, with 2-year yields about 1 percentage point higher than 10-year yields.
The last time the yield curve reversed this much was in the early 1980s, when the Fed last battled runaway inflation and resulted in a recession.
The exact time from reversal to recession is difficult to predict from the yield curve and has fluctuated wildly in the past. Still, over the course of 50 years, it has remained a fairly reliable indicator.
However, history may not repeat itself this time due to the peculiarity of the current situation. The economy is recovering from the pandemic, unemployment is low, and businesses and consumers are mostly in good shape.
“We are in a very different situation,” said Bryce Doty, senior portfolio manager at Sit Investment Associates. “I don’t think they’re predicting a recession. It’s a relief to see inflation coming down.”
