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Inverted yield curve

https://pauldeng.substack.com/p/inverted-yield-curve?sd=pf]

  • Notes:
    • Inverted yield curve is when yields on **long term debt **is below short term debt. These debt are of the same credit quality, in order to be comparable
      • i.e. 10-year government bond yield vs 2-year government bond yield
    • This has been a “reliable” lead indicator of recession. Inverted yield signals that investors believe that there is a decline in long term interest rates, which is associated with recessions.
    • A typical yield curve for a bond typically looks like
      • Attachment.png
      • Where the x-axis is maturity and y-axis is yield.
    • The spread which people look at is usually between 10-year bond and 2-year bond or 10-year bond and 3-month bill.
    • But how does it actually do to predict recession?
      • According to a published article - https://www.frbsf.org/economic-research/publications/economic-letter/2018/march/economic-forecasts-with-yield-curve/

      • Every US recession in the past 60 years was preceded by an inverted yield curve, furthermore, a negative yield term curve was always followed by an economic slowdown and except for one time, by a recession

      • However, the delay between the inverted yield curve and recession can range from 6 to 24 months for the last 6 recessions
      • A simple was built to forecast future recessions and an empirical critical threshold was used to account for the lst 3 recessions from 1985
      • If you look at the 2/10 spread from 1976 from https://fred.stlouisfed.org/series/T10Y2Y you see that large inversions are not followed by long recessions and the lag is random
      • If you look at the 3m/10 spread from 1982 https://fred.stlouisfed.org/series/T10Y3M although you see the recession following each inverted yield curve, the length and timing are not correlated to the inversion