• November 28, 2022

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The yield curve is now deeply inverted. Three months rates are well above ten year yields on U.S. government debt. The current inversion is deeper than before both the financial crisis and the 1990 recession, though not quite yet at the level before the dot com collapse of 2000.

Many voices are predicting a U.S. recession, from Jeff Bezos to many of the Fed’s own policy-makers in their economic projections. Still, the yield curve is among the more robust signals that a recession could be coming in 2023.

Why Yield Curve Inversion Matters

The yield curve has been a historically strong predictor of recessions. It tends to be a leading indicator, and has a strong track record with few false positive signals in post-war history.

Part of the reason for this is that the inversion of the the yield curve itself may be part of the reason recessions occur. High short-term rates can be recessionary, as are the signals that yield curve inversion gives to the financial sector.

Often, the Fed would worry about this, and look to ease up on rate hikes, but today they are more focused on getting inflation under control with another hike expected at the Fed’s December meeting.

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Recession Timing Is Unclear

Though an inverted yield curve implies a recession is coming, the timing is unclear. Often a recession comes about a year after the year curve inverts. The 10 year and 3 month relationship first inverted in October. That’s the most reliable relationship to watch according to the New York Federal Reserve. However, parts of the U.S. Treasury yield curve have been inverted since March 2022. All of this implies a recession could be coming in 2023.

Other Recession Indicators

Of course, a weakening housing market, corporate layoffs, a bear market in stocks and a jobs market that could be weakening all imply a recession may be near too. The yield curve is not alone in calling for a recession these days, but it’s given a strong signal as 2022 draws to a close.

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