Nords said:
So what happened the LAST time the yield curve inverted? How long did we have to wait for the recession?
Or is this a situation where a three-handed economist had eight opinions predicting six of the last four recessions?
The last inversion occurred in early 2000 with the 30-year yield falling below the 10-year. At the time, everyone blamed "technical" factors in the bond market. The US government was running a surplus and the Treasury decided to stop issuing 30-year bonds creating scarcity value in the long-end of the treasury curve. No problem, right?
Historically, the yield curve has been a pretty good indicator of economic weakness 12 months forward. I think the record is that it has only given two false signals in the past 50 years. But after each of those "false signals" the economy did slow and, in one case, GDP went negative for one quarter (not an official recession).
Although its track record is good, I'm a bit of a skeptic when it comes to using the yield curve as a crystal ball. The long-bond market is a financial market, like any other. I'm not sure why bond traders and investors are any more prescient when it comes to these things than investors in any other market.
However, the yield curve does have practical implications for the profitability of financial institutions that tend to "ride the curve" by borrowing short and lending long. The same is true for hedge funds that have exploited a very steep yield curve in the past and have been using cheap money to juice returns. So it makes sense that higher short rates will squeeze some companies' profitability, which could lead to a slow down.
The yield curve will "normalize" at some point. The relevant question for investors is whether it normalizes because a recession forces the fed to cut short rates or because the economy continues to power forward and forces the long yield to rise?
