A key metric that historically has been a precursor to a recession emerged on Friday, reinforcing fears on Wall Street — although some experts think a recession could still be a year or more out.
The yield curve inverts when the borrowing cost on short-term debt rises above the cost for long-term debt — an indication that investors expect lower growth in the future. All seven of the past recessions have been preceded by inversions of the yield curve.
“It’s a dangerous and upsetting harbinger of the future of the economy,” said Dan North, chief economist at Euler Hermes North America. “Typically, when the yield curve inverts for even a short period of time, we enter a recession about a year later,” he said. The time frame varies, he added; it has taken anywhere from two to six quarters after an inversion for a recession to occur.
That question of when is a critical one — and even the experts have different views.
“I do think when investors see the word inversion, their minds tend to link that to recession, policy error and things of that sort,” said Jim Barnes, director of fixed income at Bryn Mawr Trust, but he characterized the current inversion as modest in the context of the broader economy.
“It may not necessarily mean total negative growth, but it could mean a real slowdown,” said Peter Cardillo, chief market economist at Spartan Capital Securities. “That’s what the market is really spooked about,” he said.
Some experts suggested that the prolonged period of low interest rates, an environment that has been a hallmark of the post-recession economy, could be skewing the data in unprecedented and unpredictable ways.
“It is one of the best indicators of recession, but it’s still a terrible indicator in the sense that it has preceded all recessions, but sometimes you have an inverted yield curve and you don’t have a recession,” said James Berman, founder and president of JBGlobal LLC and an adjunct instructor in finance at NYU School of Professional Studies.
“On the other hand, it’s a sign of some distortion,” he said. “Something’s out of whack.”
