Last week the US Treasury 2 and 10 year bond yields inverted, that is the 2 year bond yield was higher than the 10 year bond yield. Historically there has been a correlation between an inverted yield curve and the next recession. Since 1956, equities have peaked six times after an inversion, with the economy falling into recession within 7 to 24 months. Will this time be different?
The Federal Reserve (Fed) purchases of US Treasury bonds as part of their Quantitative Easing programme is impacting the level of interest rates. The US yield curve might not be as inverted if the Fed was no longer buying bonds to retain their balance sheet. Therefore, it can be argued, an inverted yield curve is no longer as powerful a predictor of the next recession.
Although the US economy is slowing down, it remains in a relatively strong position, with low unemployment and rising wages. However, all it would take for the US to move towards a recession is a serious escalation in the trade dispute with China or perhaps some other unforeseen crisis. With Donald Trump seeking re-election as US President, it is unlikely that the US will escalate the trade dispute before the election in 2020.
Only time will tell whether the latest inverted yield curve will forewarn the next US, and hence global, of a recession.