One of the most accurate recession predictors is only half right, market veteran Ed Yardeni told Insider. The yield curve has been inverted for more than a year, but it doesn’t mean a recession is ahead. “But we certainly had a recession in housing. We certainly had a recession in retailing,” he explained. Loading Something is loading.
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While the yield curve is inverted, that doesn’t mean the closely watched recession indicator is predicting a downturn ahead, according to market veteran Ed Yardeni.
For years, he has been saying the inverted yield curve is an indicator for a process, not a recession. In 2019, he coauthored a paper titled “The Yield Curve: What Is It Really Predicting?” that lays out his argument.
But his views have gained renewed salience as the US economy looks more capable of avoiding a recession, while the yield curve remains stubbornly inverted. In fact, the yield on 2-year US Treasurys has been above the 10-year yield for more than a year, the longest stretch since 1980.
More recently, Yardeni has also been pushing the idea that the US is already going through a “rolling recession” that is hitting individual sectors at different times.
“When you look at it from that way, you can argue, well, the yield curve got it half right: there hasn’t been an economy-wide recession,” the president of Yardeni Research told Insider. “But we certainly had a recession in housing. We certainly had a recession in retailing, as consumers pivoted from buying goods to buying services.”
What does the inverted yield curve say?
Under normal circumstances, longer-term bonds come with higher yields, as investors demand bigger returns for lending their money for lengthier durations.
But the curve inverts when short-term yields exceed long-term yields. Generally, the common explanation is that bond traders are expecting the Federal Reserve to cut interest rates in the future in response to a coming recession.
The idea is backed by the fact that the past eight recessions were preceded by curve inversions, Yardeni said, though there have been false positives too. But for him, the inversion is telling a different story.
“What the yield curve does is it anticipates that, if the Fed continues to raise interest rates, something will break in the financial system, and that will quickly become an economy-wide credit crunch, as the credit crunches that really cause the recessions,” he said.
By those standards, Yardeni said, the inverted yield curve accurately predicted the spring financial crisis, which was sparked by the collapse of Silicon Valley Bank.
The reason a recession didn’t follow was because the Fed quickly offered liquidity to banks to prevent the crisis from spiraling further.
Is an economy-wide downturn still possible?
Despite the banking crisis fading, the yield curve is still inverted. One explanation Yardeni offered is that bond traders expect Fed rate cuts as inflation continues to slow, meaning the central bank’s war on rising prices is bound to wrap up soon.
He acknowledged that as long as the curve remains inverted, there’s room to argue that a downturn is still possible, especially as consumers begin to run out of extra savings to spend.
But Yardeni doesn’t see that. He expects the fed funds rate to start falling in 2024, citing the Fed’s own projections. This could mean a 1.5%-2% GDP growth rate, and there could be room for more, he said.
“If it grows faster than that, it can only be because productivity makes a comeback, which of course will be very good at keeping inflation down,” Yardeni said. “I mean, that would be the win-win scenario.”