The surest sign of a coming recession is not what you think, but that it is about to break out

  • An inverted yield curve is a closely watched recession indicator, but it’s not the only one worth keeping an eye on.
  • Previous inversions preceded the recession by as much as two years, making them difficult to use as an accurate indicator.
  • This is a re-slope of the yield curve, or de-inversion, which is more often followed by a recession.

Investors like to point to an inverted yield curve as a sure sign that the economy is about to hit a recession.

This is because, since 1960, every time the 10-year and 2-year US Treasury yield curve has reversed, which happens when short-term bonds offer more yield than long-term bonds, a recession has followed.

But a carefully watched signal is a poor timing tool for the market because previous inversions preceded the recession by as much as two years. And during those two years, stocks performed well in some cases.

There is another signal that investors should pay close attention to, which has historically signaled that a recession is just around the corner and not years away.

This sign is when the yield curve changes, or when short-term and long-term bonds revert to their usual higher yield setting for longer maturities.

“When the yield curve does not invert, it signals an approaching recession (within one year based on the last three recessions). While the inversion says that the problems are coming in the medium term, per year,” said Commonwealth CIO Brad Macmillan.

As the yield curve turned negative in July on the back of aggressive interest rate hikes by the Federal Reserve, it didn’t look back until at least last week.

The 10-year and 2-year yield curve was inverted by more than 1% on March 7, the steepest inversion since the 1980s. But the fallout from the collapse of Silicon Valley Bank led to a sharp decline in interest rates and resulted in the fastest three-day change in the yield curve since 1982, according to data from Bank of America.

The yield curve has more than halved its negative inversion to a negative 42 basis points this week, and if the Fed pauses in raising interest rates and short-term yields continue to fall, a full non-inversion of the yield curve will be imminent, signaling that a recession is near.

“The yield curve always turns steeply into a recession,” Bank of America’s Michael Hartnett said in a Friday note.

This is in line with CIBC Private Wealth Chief Investment Officer David Donabedian, who told Insider that “in light of the banking crisis, we believe a recession is even more likely and could be moved forward. and expansion of credit as a result of the banking crisis ahead.”

But others are less optimistic about the prospect of a yield curve deinversion and a potential recession, including Commonwealth Financial Network head of portfolio management Peter Essele.

“While the signal is worrisome, it is not yet the time to hit the pause button on stocks. Economic cycles in the late stages often bring stable returns for investors. Only after the yield curve has completely inverted does forward yield become a problem. Therefore, we caution against selling risky assets at this time,” Essele told Insider.

The sentiment echoed what Fundstrat’s Tom Lee told clients in a webinar on Thursday.

“I think inflation is broken so the yield curve is not inverted. But we haven’t really broken the economy yet.”

While the yield curve has not yet fully reversed, it has been moving in that direction since the banking crisis this week, and when it does, investors should be prepared for a potential recession and low stock returns.

Bank of America

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