The yield curve inverting is all anybody could talk about in the financial media last week. Yes, the inversion is troubling, but is it really more troubling than an incredibly flat curve? I call the chart above the “scare” chart. It is meant to show us that a certain event, in this case the inversion of the yield curve, will definitely lead to a recession. But will it? How much different is the yield curve between April 2019 and August 2019? The answer to the last question is a minuscule amount, the only real difference is that there was a negative sign attached to the number for one hot minute this month.
The reality is that there are huge growth concerns around the globe right now. Germany’s economy is contracting, China is slowing to its lowest growth levels in a generation, the United Kingdom’s economy shrank last quarter. We also know that economic growth in the US is expected to decelerate. This is all shown explicitly in the plethora of economic data available, but also implicitly in the chart above.
Now, the question on everybody’s mind is where do we go next. Notice that the yield curve almost inverted in 1994. This was right after a period of tightening monetary policy by the Federal Reserve. The Fed went on to issue some mid-cycle loosening that helped forestall a recession. Does this sound familiar? Federal Reserve Chairman Jerome Powell referenced this period in his last press conference.
The inversion of the yield curve leading to recessions also tends to be a particularly US phenomenon. The Economist notes, “In a dataset of 16 other rich countries, reaching as far back as 1960, 51 of the 95 recessions were not preceded by an inversion during the previous two years… On 63 occasions, these non-American economies kept growing despite inverted yield curves.”
Where is the economy heading? We do not know. Many signs say that growth is decelerating. We do not know if that leads to a recession or to a re-rating of the stock market to new, lower growth expectations.