Watching Another Yield Curve Inversion

Recent history of the 10-year minus the 2-year Treasury yield curve.  You can see when it briefly turned negative in 2019 and the subsequent recession in 2020 (the gray bar).  You also see when it inverted again in 2022 - and continues to go lower.

Lest there be any doubt, I am neither an economist nor an investment guru.  But I keep an eye on many economic indicators and have been watching long-term and short-term treasury yields for many years.  Back in 2019, when the yield curve inverted (short-term rates were higher than long-term rates) I knew the historical success of that indicator in predicting recessions.

Each time in the past 50+ years that the 2-year treasury yield was higher than the 10-year yield a recession has followed.  Not immediately, but within a matter of months, less than two years at most.  Most recently, the curve inverted (very briefly) in August 2019 and we experienced a recession by February 2020.

Of course, we also had the start of the COVID-19 pandemic at that time, something completely unrelated to the treasury yield.  But the brief inverting of the yield curve (it only lasted two days) might demonstrate that COVID had little to actually do with the recession.  The sour economy only lasted two months by traditional standards of measurement.  The lingering economic effects of the pandemic itself stayed with us much longer.  

Nevertheless, disregarding the pandemic, the inverted yield curve was once again the harbinger of recession.  The economic downturn would have happened even without the pandemic.  In July 2022, it happened again only this time it wasn't a blip.  As of this posting it remains inverted.  This challenges historical precedent.  

Previously, the curve remained inverted from August 1978 until May 1980 announcing what was one of the worst recessions of my lifetime.  It inverted again later in 1980, continuing with only a brief interruption until July 1982.  A double-dip recession mimicked the double-dip inversion.

The next longest period occurred in the year 2000, starting in January and ending in early December.  The recession of the early 2000's soon followed.  January 2006 to May 2007 marked another inversion which announced the coming of the Great Recession.  

By those standards, entering our seventh consecutive month of inversion is not setting any records.  But when will we see the next recession?  In these highly politicized times, many felt we entered a recession before last year's mid-term elections.  But other indicators such as strong job growth suggested otherwise.  

We have yet to string together a series of quarters with negative economic growth, which is certainly a sign of resilience.  But a recession will come.  In 2019, I was hoping that a recession would help lead to the demise of the Trump presidency.  Now I am wondering if the coming recession will help the conservative cause to retake the Oval Office in 2024.  As I stated in 2019, recessions come and go regardless of who is president.  An economic recession knows nothing of politics.  But whoever is in office always gets the blame.

This is the entire history of the 10-year minus the 2-year Treasury as tracked by the Federal Reserve.  You can see that a recession followed every inversion since 1980.  There have been six recessions of varying lengths and intensities since then.  Based on this data, we should see the seventh in the not too distant future.

The worst inversion since the Fed started keeping track came in February 1980 with a -2.01 low point.  A comparatively mild -0.43 bottom came in March 1989.  This was slightly exceeded by a -0.45 in March 2000.  The Great Recession was proceeded by a mere -0.16 low in December 2006.

Presently, we stand at -0.69 which is the worst inversion since 1980.  The Motley Fool analyzed this a couple of days ago.  According to them,  this is "ominous" for the stock market.  Past recessions have not ended without the Fed cutting interest rates, often substantially.  But because of the bite of inflation the Fed is still in the process of raising rates.  Most experts don't think there are any rate cuts in the cards until later in 2024, if then.

Of course, we are not in a recession yet.  Once that happens inflation will likely (hopefully) peter out.  So, we could see rate cuts relatively soon even though no one is expecting it.  As with everything in the economy, you get a lot of divergent opinions.  Seeking Alpha says there are plenty of solid investment opportunities despite the yield curve inversion.  The New York Times sees a "strong recession looming."  Marketwatch features an economist who says the inversion is "a false signal" and that we are headed toward a "soft landing."

All of this is to say, as I have always said, nobody knows.

In the meantime, the inversion continues to go deeper than it has in decades.  We are still a long way from the situation in the late 1970's but, back then, some interest rates were over 18% which is unfathomable in today's comparatively modest to low rate environment.  

The world has changed multiple times since then and so has every economy.  Globalization was only beginning in 1980.  Now there are those who say it is dying, or at least evolving.  What would it mean if the we have just exited a sustained period of globalization?  What comes afterward?  Nobody knows.  

The truth is we have never been exactly where we are right now before because the world has never been like this before.  Recessions will always come and go.  That seems to be a great constant.  But each recession is different, some worse in some ways, some softer in others.  Just because the yield curve is screaming recession doesn't really tell us what kind of downturn to expect let alone how long it will last.

But a recession will come, likely before the 2024 election.  That seems set in stone.  How it will impact our next presidential election cycle is a much more fluid matter.