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Yield Curve Inversion: A Red Herring – August 19, 2019

Yield Curve Inversion: A Red Herring

U.S. 10-year Treasury yields dropped to the level of 2-year yields last week, setting off alarm bells that a U.S. recession is coming.

We noted as far back as July of 2017 that a yield curve inversion would not likely provide a valid recession signal in a backdrop where Fed policy was far from being restrictive. This June, we noted that the Fed’s dovish bias distinguished the current move towards inverting from previous recessionary inversions, i.e. a restrictive Fed policy caused previous yield curve inversions and, ultimately, recessions. U.S. monetary policy is not currently restrictive by any measure. A bull flattener, as has recently been occurring, is profoundly different than a bear flattener environment, with the latter associated with the Fed trying to slow growth.

Overall U.S. monetary conditions are becoming increasingly accommodative, given the meltdown in bond yields, which is consistent with ongoing above-trend economic growth and the mild uptrend in inflation. Critically, other “reliable” recession-warning indicators are not signaling trouble ahead, such as the MRB Recession Checklist Indicator and the trend in unemployment.
Of course, all bets are off if trade developments worsen and companies stop hiring, which is not yet the case. Stay tuned.