U.S. government 3-month rates rose above the yield on 10-year bonds, according to U.S. Treasury data for Oct. 18, 2022. This is fairly unusual and researchers regard this as among the best indicators that a U.S. recession is coming on a 6-18 month view.
This indicator is among the best track records in forecasting recessions across a range of economic variables. It has successfully called all recessions in recent decades without any false alarms. That’s impressive, and among a sea of indicators, this one deserves some attention.
Yield Curve Inversion
The U.S. yield curve measure the “shape” of yields on U.S. government debt as maturities increase. Typically, as you hold U.S. debt with a later maturity, you receive a higher interest rate compared to shorter rates.
This means that the U.S. yield curve has generally had an upward slope. However, sometimes short rates can rise above longer rates and the curve slopes downward. That’s inversion.
Yield Curve Trends in 2022
We’ve seen increasing yield curve inversion in 2022 as the U.S. Federal Reserve (Fed) has pushed up rates. Yesterday, the 3-month rate nudged above the 10-year rate for the first time since before the Covid-19 pandemic (and yes, the yield curve predictive the pandemic recession, too). That change inverted what many regard as a critical relationship in the U.S. yield curve, signaling a coming recession.
The yield curve is well studied given its strong track record and there are various ways to interpret it. But researchers at the New York Federal Reserve suggest that the 10-year rate less the 3-month rate is likely among the best indicators of a coming slowdown in economic activity. That’s the relationship that just inverted.