There have been talks of recession hitting the United States again. Extremely shocking manufacturing data from the US today is probably partly fueling the talks.

Although prediction is a risky game, there are various indicators one can use to gauge the likelihood of a recession. One of them is the US treasury yield curve.

An inverted yield curve may signal a recession, or at least some kind of pessimism in the market. The reason is that market participants will expect rates to go down during a recession. Future inflation rate meanwhile is expected to decrease as demand dies down. With those expectations, the bondholders will not require too high a returns.

Now, despite the talks, the current curve is sloping upward.

As you can see, the three yield curves in the last few weeks have been well behaving, unlike the one about 3 years ago just after the peak of the financial crisis. The September 2008 yield was inverted up to 2-year term.

So, there is no recession in the current yield curve. At least, not yet. Quite the contrary (unless we will be seeing stagflation), there is considerable inflationary expectation beyond the 5-year term relative to now; it is a pretty steep curve. That may suggest some kind of recovery.

Nevertheless, looking at the yield curve right now might be flawed, just because the Federal Funds Rate is already close to zero. Given that the US is possibly in a liquidity trap, the yield curve cannot be inverted.

Still, a relatively flat curve could be used as a signal of recession, especially if liquidity premium theory is taken into account. If the curve keeps sinking like it has for the past few weeks (so far, it seems to be due to flight to security phenomenon), we could be seeing a flat yield curve in a couple of months. Then, the case for recession will be stronger.

Of course, the curve should be viewed in context of other data for one to have a more educated guess about the future.

Another story is that the yield curve has been sinking lower and lower. The market is telling S&P something: S&P has got it wrong.

One Response to “[2413] Looking for inverted yield curve”

  1. […] reading my last post on the yield curve of US treasuries, a friend asked if those curves replicate those seen during the Japanese Lost […]

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