- Economists view the inverted US bond-yield curve as an indicator that a recession is coming.
- Yields on Treasury bonds remain to the upside, which could be a classic recession warning.
- But according to Goldman Sachs, it is not worth worrying about the yield curve now.
The classic bond-market barometer of economic health — the yield curve — is still signaling a recession, according to Goldman Sachs, but it may no longer be a reliable metric.
The widely followed indicator is near its most inverted level – meaning it is considered normal – in more than 40 years, and such anomalies are usually taken by economists as a sign That a serious economic downturn is on the way.
But this time, that doesn’t seem to be true, Goldman strategists Pravin Korapaty and William Marshall said in a research note published Wednesday. Instead, curve inversion may be due to lower inflation-adjusted interest rates, they wrote.
“Our analysis above strongly suggests that a substantial portion of the inversion seen in current US yield curves does not come from higher recessionary odds or normalization of inflation,” the strategists said. “We think the extent of the inversion, especially in the real curve, is unlikely to persist.”
The yield curve is a graph that plots bond rates at various maturity dates – and in a normal economic scenario, a loan repaid at a later date will pay a higher rate. An inversion occurs when that logic is followed, resulting in long-dated yields falling below those of short-dated ones.
A relative decline in far-maturity bond yields generally suggests investor expectations that interest rates will fall over the long term, which economists take as an indicator that a recession is coming. A popular way to track yield-curve dynamics is to compare the returns offered by 2-year and 10-year Treasury notes.
The US bond curve, as represented by the difference between the 2-year and 10-year yields, is nearing its most inverted level in four decades. The upside deepens in 2023, despite growing optimism that the US economy is strong enough to avoid recession.
“The current levels of inversion at various curve segments suggest fairly high bearish odds when using simple, but generally statistically reliable, regression models,” Korapaty and Marshall said. “Yet even as the growth outlook improves — our economists recently lowered their recessionary odds — the curve inversion deepens.”
But strategists believe it’s time to stop listening to the yield curve — because financial markets have failed to realize that the US economy is strong enough to tolerate high inflation-adjusted interest rates for a sustained period. is strong.
The Federal Reserve raised borrowing costs from nearly zero to nearly 4.5% last year to quell rising inflation.
A sharp increase in interest rates would generally be expected to harm the economy. But various indicators – like the US adding a better-than-expected 517,000 payrolls last month – suggest there hasn’t been much of a slowdown in growth.
So it’s likely that fixed income investors’ assumptions about the equilibrium level of interest rates are out of whack, according to Goldman Sachs. “We believe this cycle is different, with an economy that can support higher long-term real rates than currently anticipated,” Korapaty and Marshall said.
Goldman Sachs’ views on the yield curve conflict with those of many other economists.
Duke University finance professor and yield curve guru Campbell Harvey said in December that the inverted curve was still indicating there would be a recession — and called on the Fed to stop its tightening campaign too soon.
Read more: Goldman Sachs says chances of US slipping into recession now just 25% due to jobs boom