There is a pretty good correlation between a flat or inverted yield curve and the occurance of a recession within 1-2 years. Well, we are there - the inverted yield curve, that is.
This excerpt from an FDIC economist’s explanation of what the yield curve does (and doesn’t) tell us is pretty clear. The chart needs some explanation, IMHO…
The line goes up as the difference between the 10-year and the current Fed rate (yield curve) increases but this isn’t the important part. As the rates converge, the line goes down, indicating a situation that may become problematic. If the current rate becomes larger than the 10-year rate, the difference is negative and the yield curve is said to be inverted. This is especially bad.
On the chart, there are horizontal rules. The table on the right shows the historical probability of a recession when the yield curve has been in that range. Generally, when the difference is substantial and positive, the likelyhood of a recession is low as indicated by the percentages in the table. The line goes up during recessions as the rates diverge and return to “normal”. When the difference is low or even negative, the likelyhood of a recession is high.
The blue vertical bars indicate the years of actual recession. Notice that they are usually 2-3 years wide and follow a low point, sometimes immediately, sometimes with a lag of a couple of years. The legend is misleading - the recession isn’t the period between the vertical bars, it is the width of the vertical bar.
There have been lots of recessions following the inversion of the yield curve. Can the next recession be far behind?
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