For the past year or so, many economists and financial analysts have been predicting a recession based on bond rates falling to an inverted yield curve. But instead of slowing down, the US economy has shown signs of recovery with strong employment data, declining inflation and overall growth. Some analysts say the yield curve may not be as reliable a predictor of recession as is often believed, while others think it is too early to tell whether the curve correctly assesses the economy in either direction.
Can an inverted yield curve still predict a recession?
Campbell Harvey, a Canadian economist, was the first to identify the yield curve trend, and he still thinks a recession is coming. “It is too early to say that this is a false signal. Very quickly,” Harvey told Yahoo Finance.
The yield curve is the difference between short-term and long-term Treasury bonds, calculated as the difference between either a 3-month Treasury bill and a 10-year Treasury bond, or a two-year and a 10-year bond. According to YCharts, as of August 24, 2023, the spread between the 3-month bill and the 10-year bond is -1.35%. On the other hand, the difference with a two year note on the same date is -0.75%.
An inverted yield curve occurs when the discount rates on short-term bonds are higher than long-term bonds, creating a negative differential. In a growing economy, the yield curve is rising because investors generally believe that long-term bond rates will go higher as central banks raise rates to avoid inflation if a strong economy grows too quickly. increases. When the yield curve inverts, it is because investors expect an economic downturn to prompt central banks to cut interest rates.
An inverted curve can start 24 months before a recession. So far, the 10-year/2-year curve has been inverted for 13 months, while the 10-year/3-month curve has been downward sloping for 10 months, according to data from LongTermTrends. Meanwhile, US stocks have had positive results, with the S&P 500 up nearly 14% for 2023.
“The longer we go after the inversion, people start to doubt the indicator, which is fine.” Harvey said. “I picture it as the calm before the storm.”
But some analysts say this post-Covid economy is different. For these people, the inverted curve concerns more than two years of near-zero interest rates that don’t end until May 2022, and the demand for the safety that long-term Treasuries will offer if the Federal Reserve starts cutting rates. . In 2024.
“Overall, the yield curve has flattened below recessionary indicators over the past two economic cycles,” said Ellen Zentner, US chief economist at Morgan Stanley. “And when we look at factors in the economy that are typically signs of a recession, such as job growth, retail sales, real disposable income and industrial production, we do not see signs of a recession.”
How should investors react to their portfolio?
Should investors put their money in short-term bonds and avoid stocks before the recession hits stock prices? Or should they listen to positive economic signals and stick with stocks that may move higher?
For retirement investors, the most common answer is to invest in a diversified portfolio of stocks, bonds and cash that can provide the income needed for 30 years of retirement. Remember, however, that everything that goes up in the financial markets eventually comes down.
This retirement calculation depends on whether you have a pension, your expected Social Security benefits, your savings and other assets, as well as your own personal risk tolerance. Ideally, a retirement portfolio is built to take on the least amount of risk necessary to provide steady retirement income, even when a recession hits. You may also want to monitor and adjust your portfolio strategies to keep up with your long-term goals.
The US economy may or may not head into a recession, but smart investors know that a recession is inevitable and structure their portfolios to minimize risk. Investors traditionally rely on the inverted yield curve to predict lower growth, rate cuts and tightening of credit conditions during recessions. But it can also be an unreliable indicator as experts point out that it cannot predict the timing or severity.
Tips for investing in recession
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