Politics, Policy, Economics - Since 2010

If the long bond decline and other rate declines have you worried it may be worthwhile to read the below from Goldman Sachs: The ...

The Yield Curve Does Not Indicate Recession Risk




If the long bond decline and other rate declines have you worried it may be worthwhile to read the below from Goldman Sachs:

  • The historical correlation between yield curve inversion and recession is impressive. But what exactly is an inversion of, say, the 2s10s curve supposed to tell us? Roughly, an inversion indicates that the monetary policy stance is restrictive or is expected to become restrictive.
  • This signal has worked well historically because US recessions have tended to follow overheating that led to restrictive policy. But it raises two problems. First, it is inconsistent: the decline in the term premium has dramatically changed the signal about the restrictiveness of policy. Second, it is narrow: recessions do not have to be preceded by restrictive monetary policy.
  • This does not mean that the yield curve is useless for assessing recession risk. In our view, the “wisdom of the crowd” embodied in the yield curve can provide useful input on two questions. First, the near-term forward spread provides a sense of the market’s view of the economic outlook. Second, the market’s view of neutral helps us judge how far into restrictive territory we have gone. At the moment, however, neither measure indicates heightened recession risk. In gauging overheating risk, we think it is more straightforward to look directly at the economic data.
  • We currently see moderate cause for concern: while price and wage pressures look contained for now, the US unemployment rate is headed to historically low levels.