Inversion of the yield curve: is a recession around the corner?
The news panicked markets: the yield curve inverted, with the two-year Treasury bill rate becoming higher than the 10-year rate. Donald Trump went full on panic mode:
..Spread is way too much as other countries say THANK YOU to clueless Jay Powell and the Federal Reserve. Germany, and many others, are playing the game! CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win!— Donald J. Trump (@realDonaldTrump) 14 août 2019
Indeed, this is cause for concern: an inverted yield curve has preceded every modern recession. However, it doesn’t automatically augur one, as the yield curve sent some false signals in the past. For example, in June 1998, there was no recession after a brief inversion of the yield curve.
According to data from Wells Fargo, the yield curve Probit model estimates a 32.7% probability of a recession this time, marking the highest estimate since the Great Recession. However, it states that this remains below the probabilities indicated prior to the past three recessions. But this is because it has not been inverted for long. “If the yield curve were to remain inverted for about six months the probability of a recession would likely be boosted to a historical high,” it concludes.
So what can we take from this? Well, it might be too soon to panic. While the inversion of the yield curve is not a good omen, for now, there is no certainty that a recession is around the corner.