Why Investors Are Obsessed With the Inverted Yield Curve
The yield curve signals a recession
Duke University professor and yield curve creator Campbell Harvey said investors should start preparing for the next economic downturn.
«It’s time to develop a strategy. Easily manage assets when the economy is booming. But it is better to have a clear plan of action than to be in a situation where a crisis comes and you have to improvise», – he thinks.
Harvey spearheaded the effort to investigate the inverted curves observed when short-term Treasury returns are higher than longer-term ones.. During his research, first identified in 1986, he found that an inversion between three-month and ten-year treasuries predicted the last seven recessions since 1950.. At that time, there were four successful cases, and since then there have been three more such precedents..
In the very last cycle, this part of the curve first briefly went up in March, and then dropped again in May, where it remains to this day.
According to the professor, for reliability, the curve should remain inverted for three months, so the current duration means that the indicator warns of an impending recession.
How The Yield Curve Predicted Every Recession For The Past 50 Years
The only bright spot is that those watching the indicator can plan ahead.. Inversion is not a random indicator, but rather indicates recessions of 6 to 18 months. Thus, the business can respond to this by planning costs until the situation improves..
«If you cut back a little, you can provide yourself with a safety cushion in case of a crisis. Recession forecast could take risk management to the next level», – Campbell Harvey notes.
Fed officials consider the Harvey indicator as one of the methods for assessing the economy.
Some market participants are more focused on the balance between two and ten-year bonds. This part of the curve briefly changed the vector at the end of August, but then showed growth again.
There is also no guarantee that the inversion will drive stock prices higher. Research done this year economists Eugene Fama and Kenneth French, found no correlation between inversion and the stock market that received less government bonds.