Friday, August 29, 2014

Are we going to have to wait for an inverted curve?

Nice review from ETF guide on the issue of inverted yield curves and recession prediction. Inverted yield curves have preceded all the major recessions in the US. If you had one market based tool to determine whether there will be a recession, this is the tool. You don't need any government data. You don't need any sophisticated statistics. All you need is some data on yields for different maturities. You can get the information from the FRED database.  

The important question is whether the market has changed so much that this time is different. By listening to the Fed, the only conclusion is that there is no recession that is possible because short rates are close to zero and long-bonds are significantly higher. There can be significant flattening of hundreds of basis points and we still would not get the inversion necessary for a signal. There is no need to worry. This is no need to anticipate a recession.

My big worry is that we can have a recession with no inversion. Yes, this is a low probability event. We would have a recession without a tightening of credit. So what does this mean? It would say that we can have tighter credit conditions and recession without a corresponding increase in short rates. This is worth thinking about. It would be a unique situation.

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