Recession Predicted by the Inverted Yield Curve

Mike Wilson, chief U.S. equity strategist at Morgan Stanley, has adjusted the yield curve inversion for quantitative easing and quantitative tightening. He believes that it predicts a recession.

When long-term rates are lower than short-term rates, the yield curve is “inverted,” and this has been a very accurate recession predictor in the past.

An inverted yield

29 thoughts on “Recession Predicted by the Inverted Yield Curve”

  1. Earned income comes primarily from two sources, wages and investments in capital. Historically stable, this percentage balance is beginning to change drastically in the direction of investments, at the expense of wages.
    This will escalate over the next decade as rapid automation could eliminate jobs two to three times more rapidly than ever seen before and, as the investment surge recedes, is likely to leave deeply asymmetric economies in which income and wealth is highly concentrated among those that tend to save and invest, rather than consume. Growth could become enormously constrained by a reduction in demand and the impact of this wouldn’t be fully felt until the boom slowed. Thus, this huge investment surge could abruptly be curtailed in stagnation.

    Some futurists have come forward with the idea of a universal basic income, to protect against poverty and reduce or eliminate stagnation in demand (seemingly ridiculous amidst such plenty, but all too likely). Aside from resistance from various quarters, “Dagnation, if they needed more money they should have inherited more money, like I did!” the bigger problem would likely be that, historically, individuals don’t seem to do well when too much is just given to them.
    Expect George Jetson economies eventually. Ones where, despite his housekeeper robot, Rosie, being able to do his job way better than he can, George still has a make-work job if he can’t be at least somewhat productive on his own.

  2. Over the past 50 years (not exactly a long time in the history of finance), an inverted yield curve has been followed by a recession and, yes, we currently have an inverted yield curve.
    The current inverted yield curve has two root causes.
    1) Investors convincing themselves the extended boom period had made a recession more likely than normal — whatever normal is.
    2) Central banks increasing short-term interest rates without adequate reason.
    Obviously, neither reason makes an immediate recession unavoidable. Meanwhile, other fundamental changes in the economy may actually indicate a boom. (This is not to say that, even if this is true, there won’t be corrections along the way.)
    Further reasons why there may not be a near-term recession include:
    1) AI and machine learning are becoming a real factor in increasing productivity.
    2) AI reduces likelihood of high inflation.
    3) China/US relations will find a balance when the saber rattling is over.
    4) Government debt levels (relative to GDP) may drop with increased government automation and increased corporate profits.
    5) A rapid (what other kind can there be?) rollout of automation technology over the next decade is likely to trigger a massive investment surge involving trillions, possibly tens of trillions, in the US alone. A great deal of output would likely be directed back at meeting investment demand and drive overall growth rates to levels not seen in decades.
    But don’t expect investment utopia forever.

  3. Not one Democrat or government official went to jail, even got indicted even with conservatives in control of the entire government. I bet conservatives wish they could say the same, but they can’t. I no longer trust Trump in office, and I have not had a shred of respect for conservative “leadership” for decades after I fell for the “Clinton killed his bodyguard in Arkansas” conspiracy theory. You may not like what I think, probably don’t, but at least I am thinking instead of being told what to think. Guess what, I already read the report for myself. That’s why I am so angry, but unfortunately not surprised.

  4. The FBI doesn’t spy and there would have been no point to it, no upside for them. Mueller laid out no less than ten obstruction incidents that would have landed anyone not the president in prison, as noted by over 1000 prosecutors and federal judges recently. So why? Why would Trump and associates risk felonies and prison sentences for obstruction if he had nothing to hide? Anyone who wanted to see where all this is coming from simply needs to read the report, it is a legal masterpiece that lays it all out. Notice how Barr and Trump are no longer crowing about “full exoneration” any more? Barr lied about the reports findings, Trump lied and Mueller had to go on the news to set the record straight.

    Their answer to a real investigation is conspiracy theory garbage, unsubstantiated mental vapor. Of course the Trump base is falling for it, they’ve been conditioned to. Pizzagate, Benghazi, Hillarie’s emails, the list of conspiracy theory goes on and on. Anyone with a brain would realize that, with conservatives in control of the Senate, Congress and Presidency, that would have been the time to move on all of them if there was any criminality to any of it. They never did anything with it, did they? It was all garbage, and Trump’s base falls for it over and over. This is why I am conservative leaning but an independent voter. I got tired of being lied to by people not smart enough to fool me more than once.

  5. The balance sheet of the FED is skewed towards short term securities. And in the environment of aggressive QT, the yield curve will tend to flatten. If you go too far/fast, it will invert. So I believe the FED through its overly-aggressive QT has caused this inversion. The FED appears to know this, and has indicated two things: (1) no further rate increases this year, and (2) it has indicated its intent to ease-off from the rate of balance sheet unwinding.

  6. Gary -“Trump is also basically daring the Democrats to impeach him and sooner or later they’ll take him up on it”
    hahaha, they have been trying their hardest to dig up dirt on him, to impeach him, they have left no stone un-turned, and 2½ years later…..crickets.

    The Dems don’t even have a good contender, they have leaned so far to the left, that 90% of them running are proud socialists. So you might not like it, but Trump is a shoe in for 2020. Congress needs to accept that he IS their president, and get on board with him, and do what’s best for the country, not their future democrat prospects.

    I do however agree that the mexico tariffs, is not the right solution for having Mexico solve their border crisis. The solution is to impose stiff fines on Americans hiring illegals. Crack down very hard on that, and then the word will get out that it’s virtually impossible for illegals to get a job, which will stop 90% of the flow of illegals into this country. I’d also pass a law that states “if you enter the U.S. illegally or overstay your visa, you will never be granted citizenship.”.

  7. The treasury yield curve inverts for a bunch of reasons. Generally, investors are piling into longer date risk-free paper and away from cash and equities. Basically, risk-off, sort of. Investment grade bond funds are still doing quite well, so it’s a bit of a mixed thing. One thing for sure, is that inverted yields on treasuries always are self-correcting and temporary.

    Folks like Morgan Stanley is on the sell side and would like nothing better to sell these dumb money investors more longer dated bonds, which I am sure MS has a ton of in their inventory. MS probably loaded up on the bonds when prices where much lower last year.

  8. You need to remember Morgan Stanley is on the sell side. When investors are willing to get paid LESS than the “cash” short term rate, there is a me-too effect and MS has a huge bond inventory and more than willing to sell longer dated bonds AT A HIGHER PRICE (given price and yield are inverted)……

    Not much else to see here.

  9. So, because party A is not held to account, and/or the accusers are themselves hypocrites, therefore party B should not be held accountable for their actions?

    Nope, that is to be blunt, bullsnot. Even presuming the facts stand as stated, you are advocating that we perpetuate the damage of the former through our apathy toward the latter. It doesn’t fly for Mai Lai, doesn’t fly for Abu Ghraib, and it doesn’t fly here. Though the political good of the country may sometimes argue against it, holding people accountable for great crimes is never in itself a pointless act. Period.

  10. Um – because I neither tried to nor did comment on the Muller report?

    I commented on what I think the presence of lack of a few things in the Muller report would signify, vis-a-vis certain political opinions which you hold in a negative light. I think that is both valid and substantive, just not relevant to the report itself.

    I did also note that you framed the issue in a leading way, but often the context-free limits and informal nature of a forum such as this pretty much demand that, anyway. :-/

  11. Don’t tu quoque. Trump has broken all records of lying, he’s off the charts. Comparing Democrats, or whatever, the commies, or whoever, the French for all we care, on the basis of lying, is not going to lead to anything except sheet sandwich.

  12. No much like more often than not someone will be lazy or stupid and say “no offense but…” and then say something primarily offensive, you precede commentary on Mueller report by saying you haven’t read said report.

    What kind of backwards public, private, or autonomous education does one have, to not realize that that’s nonsensical?


  13. BS predictor. The yield curve inverted 2005/6/7 and 2018, all without a business cycle recession (2008 was a credit pull back irrelevant to the yield curve). This is the problem of trying to apply what could be, but isn’t necessarily, a causation in the past, where the “business model” of the economy was vastly different to the current model (e.g., the Volcker inflation days and the Fed wasn’t the bond king).

    Also, stock market prices aren’t effected by the yield curve (e.g., 2011).

    “past performance is not a guarantee of future results”…..

  14. There is almost always something that causes recessions so it’s not useless to know that a recession will occur in the near future and what sector of th economy it will effect most. Right now the immediate systemic risks are personal and corporate debt…

  15. Some of them are quite rich… but many of them are fairly marginal in their predictive abilities. The metric in question is simply a measure of peoples confidence in the economy. A sudden big lose of confidence is sometimes enough to cause the market to crash but the best analysts look at the fundements and spot systemic weaknesses like the crazy housing market, bad loans and the massive amount derivatives that caused the Great Recession.

  16. Do you seriously want to make ‘supporters of Trump serving out his term/s of office forfeit the right to call out deceit, corruption and illegal acts against any and all holders of public office’ your standard here?

    Philosophically, that would seems like a slightly dangerous tack for a free(ish, more or less) country.

  17. Really? So saying ‘Unless the Mueller report meets criteria X, the ‘Russian collusion’ campaign against Trump has a whiff of conspiracy because of reasons Y’ is not pertinent?

    I mean, I clearly stated lack of familiarity with details of the report, then put out specific criteria for how the report in my opinion, should bear on Trump one way or the other, depending on details in said report. Seems substantive and topical to me….

  18. <<Well, I’ll have to read the Mueller report myself to comment intelligently on it, but >>
    Nothing follows worth reading.

  19. What is an accession prime predictor; I’ll take my answer A.) within theoretical p$axis…

    Classroom Aid – Quantum Chromodynamics QCD

    John M Smart – A.I., “Inner Space,” and Accelerating Change
    Cannabis Real Estate Leases: The Roots of Your Cannabis Business, Part 1

  20. Yes this yield curve (and Canada’s etc.) inversion tracks the US President’s trade intervention announcements.

  21. It’s the difference between the bond yields of different maturities.

    RIght now 10 year is 2.22 and 2 year is 2.06. If 2 year goes above 10 year, say to 2.30, then you’d say the yield curve between the 2 year and 10 year bonds are inverted by -0.08 (8 basis points).

    Morgan Stanley is arguing their 3 month to 10 year comparison requires you drop the 10 year by an additional (like -0.45) to make up for additional distortion from the activity the fed itself is doing.

  22. Quantative analysts are quacks, if they where able to predict the stock market by looking at graphs and making calculations then they would be the richest people on the planet. Yet it is the Warren Buffets and Charlie Munger’s of the world that make the most money. They might be more usefull as negative predictors, make’s me think a recession won’t start anytime soon.

  23. Well, I’ll have to read the Mueller report myself to comment intelligently on it, but unless there is actual, positive evidence of Russia’s government actively colluding with Trump, during his campaign, in a coordinated way through bribery, special favors, etc. for explicit purposes of intentional disinformation, vote-rigging, quid-pro-quo political favors, etc — then yes, the scope, tenacity, ferocity and breadth with which the narrative of Russian collusion has been promoted from the very beginning, with claims running far ahead of evidence at the time, does have a whiff of conspiracy about it.

    The accusations brought against Trump since winning the election have been exactly in line with the thesis that the Clintons’ modus operandi is to take things of which they are accused, and hurl those same indictment against their opponents, as long and as loud as possible. The Clintons have, at minimum, their own shady history, the repeated tone and multiple factual errors in the much of the press’s coverage during the campaign( when I was following, and I suspect has continued) gives a natural sense of accomplices, and the general idea of Trump’s promise that if he were president, Hillary would ‘be in jail’ still stands as promised action not yet made good.

    Notice how your statement filters developments to a predetermined conclusion: Mueller’s investigation was fact-finding about a legitimate concern of national security, while Trump’s investigation is ‘Chinese politics’?

  24. Predicting a recession is like predicting you will get a cold.
    I’m sure it will happen but unless there is a timestamp on when the prediction will occur,
    It is useless.

  25. OR the yield curve is inverted because of our trade war. Call off the trade war or escalate it into a shooting war or proxy shooting war and maybe recession will be averted.

    I’d be very nervous if I was in North Korea or Iran.

    Recessions are bad for incumbent politicians, wars (even insane unjustifiable ones) are good for them.

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