Is a Recession on the Horizon

According to an article in the Business Insider, a key metric for the onset of a recession is leaning towards a downturn. In this case, the yield on 10-year US Treasury notes declined for a fifth consecutive week and is close to the yield on a 2-year Treasury. According to the article:

"Treasury yields don't automatically trigger recessions, of course. But there has been a worrying historical correlation between the moment that the percentage yield on the two-year Treasury becomes greater than the yield on the 10-year note. That phenomenon is called a "yield curve inversion," and it means that investors are so worried that they're much less likely than normal to bet on short-term assets.

When the opposite happens and investors signal that the short term feels riskier than the long term, something must be wrong. If investors say they have less idea of what's going to happen in two years than in 10 years, then they must be very worried about the near term — and that is a pretty good signal of an impending recession.

When the two-year exceeds the 10-year, recessions tend to follow in short order."

There is one reason not to panic. The yield curve doesn't say that a recession will come imminently. Just sometime soon. The Macquarie analyst Ric Deverell and his team told clients recently that even if the curve were inverted, a recession might not show up until 2019, based on the historical record.

"Indeed, each of the five most recent recessions were preceded within two years by an 'inverted' yield curve, with only one false signal (the yield curve very briefly dipped into negative territory in mid-1998, during the Russia crisis and the collapse of Long Term Capital Management, around 33 months before the cyclical peak).

"On average, the lag between yield curve inversion and the onset of a recession is around 15 months ... Even if the current trend pace of flattening since 2014 were to persist, the curve would not invert until the middle of 2019."

While the 10-year yield still exceeds the 2-year yield, the differential is small -- 25 basis points on Monday, the flattest since 2007.

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