The father of the "yield curve inversion": Top recession indicator now slowing down the economy
The creator of the yield curve inversion indicator pointed out that this recession indicator is now affecting the economy, usually occurring when long-term bond yields are lower than short-term bond yields. Duke University professor Harvey stated that this indicator has successfully predicted eight recessions since the 1960s, and the current inversion has lasted for about 20 months. Although the inversion of the yield curve prompts companies to make cautious investment decisions, Harvey mentioned that the Fed's tightening policy needs to be repaired through rate cuts. He believes that this indicator has the potential to help companies manage risks and assist in economic recovery, rather than leading to a severe recession
The creator of the yield curve inversion, which has a decades-long track record of accurately predicting recessions, has stated that this recession indicator has now exceeded its warning function and is starting to impact the economy.
When the long-term bond yield falls below the short-term bond yield, a phenomenon known as yield curve inversion occurs. This is an abnormal situation that historically occurs when investors are concerned about short-term growth risks and demand higher returns.
Duke University finance professor Campbell Harvey, the original creator of the inverted yield curve as a leading recession indicator, stated in an interview last Friday that since the 1960s, this indicator has successfully predicted every recession out of the past eight without any false alarms.
The indicator has been flashing for about 20 months continuously, with no recession occurring during this period, leading some to doubt its accuracy. However, Harvey pointed out that historically, the lead time for this indicator ranges from 6 to 23 months.
He added that the yield curve inversion has recently become a "causal mechanism" that could potentially slow down economic growth.
He said, "So when people see an inverted yield curve, their behavior changes. As a CEO, when you see an inverted yield curve, you are less likely to make those all-in investment decisions."
Harvey stated that the Federal Reserve's aggressive tightening policies led to the yield curve inversion, and now aggressive rate cuts are needed to rectify this damage.
The Fed's rate hikes have helped reduce CPI inflation from 9.1% in mid-2022 to 2.9% in the latest data, the lowest year-over-year growth rate in three years, during which the economy has cooled down.
Harvey explained that given the strong predictive record of the yield curve inversion and its ability to change behavior, it can also be used to help manage risks. This means that if a recession occurs later this year or early next year in the United States, businesses will be prepared.
Otherwise, a sudden recession would catch businesses off guard, forcing them to lay off workers suddenly, exacerbating the economic downturn.
"So, you can see this indicator as actually slowing down economic growth, but it leads to a situation where we can experience a recession but avoid a hard landing," he added. "In other words, economic growth will slow down, rather than a situation like the global financial crisis."
Over the past week, soft employment reports initially raised alarms. Despite some easing of recession concerns, doubts still linger. For example, due to economic concerns, gold prices have hit new historical highs