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Why the inverted US yield curve need not mean a recession is on its way

Aug 31 2019 18:45
Compiled by Carin Smith

This month the US yield curve, specifically the difference between the ten- and two-year US Treasury bond yields, turned negative.

This means that the US government would pay less to borrow for ten years than two years.

This is particularly important as this spread is seen as an omen for recession by many investors, causing trepidation across financial markets. According to FNB chief economist Mamello Matikinca-Ngweny, it is worth noting that this inversion has preceded all US recessions for the last 50 years.

Previously, inversions of the yield curve were preceded by a combination of increasing inflation and short-term yields in response to an overheating economy.

However, the circumstances of the current inversion differ to those of the past, according to Matikinca-Ngweny.

They point out that, this time around, long-term yields have fallen as fears of a global slowdown have spurred capital flight from equities into bonds.

In addition to this, the vast quantities of bond-buying by pension funds and central banks may also be attributing to artificially lowering long-term yields, diminishing the predictive ability of the inverted yield curve.

The environment differs from past inversions as US unemployment is low, inflation is controlled, wages are rising, the economy continues to grow above 2%, and the Dow Jones Industrial Average remains relatively steady.

Matikinca-Ngweny says that, if the inversion does point toward a slowing US economy, the US Federal Reserve still has room to lower its policy rate to accommodate and support growth through consumption and investment-related activity.

However, while the Fed may decide to cut the federal funds rate even further before year end, this may well be overshadowed by a further escalation in the US-China trade war.

US-China trade tensions have been at the centre of global uncertainty and fears of a possible recession. Markets anticipate that these tensions will continue over the near term.

If these frictions escalate further, global growth will most likely fall below its historical trend. This would diminish the ability of the Fed and other central banks to circumvent slowing economic growth as monetary policy rates are already low.

While the ten- and two-year spread has a large following among investors, the timing from inversion to recession has been less predictable, casting doubt on whether the indicator remains a reliable one for recession, according to Matikinca-Ngweny.

This is because the time between inversion to recession has increased over time.

us  |  recession  |  world economy


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