Known among economists and Wall Street traders as a “yield curve inversion,” this economic indicator has hit the three-month mark. When this has happened all 7 times previously, the result was an economic recession.
We are now in the longest expansion in history, yet the data is all pointing to an upcoming recession – one that could make the Great Recession look calm by comparison. The inverted yield curve has been ongoing for three months now. That refers to when long-term interest rates are paying out less than short-term rates. It’s been a gloomy sign for the economy in the past and if history is any indication, we will soon be in for a very bumpy ride.
According to a report by NPR, the inverted yield curve has been flattening out and sloping down for more than a year, raising concerns among some analysts that investors’ long-term view of the market is not positive and that an economic downturn is looming. As of Sunday, the yield curve has remained inverted for three months, or an entire quarter. For over a half a century, this has been a clear signal that the economy is heading for a recession within the next nine to 18 months, according to Campbell Harvey, a Duke University finance professor who spoke to NPR on Sunday. His research in the mid-1980s first linked yield curve inversions to recessions.
“That has been associated with predicting a recession for the last seven recessions,” Harvey said. “From the 1960s, this indicator has been reliable in terms of foretelling a recession, and also importantly, it has not given any false signals yet.”
“Yes, the economy looks good right now,” Harvey added. “But the yield curve is about the future,” he said. “It captures the expectations of the broad market in terms of what might happen in the future.” However, others disagree that this means the United States economy is hurtling towards a recession. Randal Quarles, the Federal Reserve’s vice chairman for banking supervision, has declared that the gap between short- and long-term interest rates does not mean the U.S. is moving toward a recession, wrote NPR.
With consumer confidence dropping, Harvey says the inverted yield curve could be a sort of “self-fulfilling prophecy.” However, considering very few American consumers are even aware of what this economic indicator is and the data points surrounding it, that seems unlikely.
The idea of an inverted yield curve remains hard to grasp, so Harvey suggests to think of it this way: a yield curve is the difference between a short term cash instrument, like a three-month government bill, compared to a long-term one, such as a 30-year government bond. When the short-term ones are paying out more than the longer-term ones, something is wrong. And economists call it an inverted yield curve. “If you lock your money up for five years, you expect to get a higher rate than, say, locking it up for six months,” he said. “But in certain rare situations, things get backwards and it turns out the long-term interest rate is lower than the short-term rate, and that’s called an inverted yield curve. That’s exactly the situation we got now, and it is a harbinger of bad news.”
In order to prepare for a recession, you’ll need to get your personal finances in order. We harp on this a lot, but it’s only because we want everyone to be prepared for what’s coming. Pay off your debts and save up an emergency fund so you can weather the storm. Obviously, the less money you have going out, the less you’ll need coming in. Dave Ramsey’s book The Total Money Makeover is a great resource. Also, consider signing up for James Davis’ newsletter at Future Money Trends. It’s free and you get it via email. He’s got excellent tips about how to grow your personal wealth even during an economic crisis.
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