Once lionised as the ‘rock star’ of economic indicators, the inverted yield curve is now something of a busted flush. The curve, which delineates the difference in yield between long- and short-dated US government bonds, used to be viewed as a barometer of global financial health or even as a catalyst for recession itself.
This is understandable. Every US recession since the Second World War has been preceded by an inverted yield curve (specifically by the yield on one-year Treasuries moving above that of 10-year Treasuries).
But in my view the inverted yield curve’s status as a predictor of recessions is overblown and outdated. While its reputation for predicting the future was well deserved when monetary policy was “normal” – when, generally speaking, recessions were generated by central banks – in the post-GFC world things are very different.
Recessions these days are far more likely to be caused by financial variables going wrong and creating crashes. That’s true of the Asia crash in the late 1990s, it’s true of the dotcom recession, it was particularly true of the GFC and it was true of the eurozone crisis since then.
The days of central banks engineering recessions through interest rate rises is long gone – particularly in the current climate where, if anything, there’s a real fear of inflation undershooting and not reaching its target.
And, if inflation has lost its central role as a catalyst for recession, then so too has the inverted yield curve as a tool for understanding when a recession might come.
Shamik Dhar, chief economist, BNY Mellon Investment Management.