Even if you were on vacation last week, you know that the bond yield curve inverted on the 2/10 spread for the first time since 2007. It happened right before the Great Recession hit. Historically, an inverted yield curve means a recession will soon follow. So – is a recession upon us?
Maybe, maybe not. The thing to understand is that they are psychologically driven more than anything. As soon as the “R” word is muttered, people start spending less. In an economy driven by consumer spending, a recession becomes a self-fulfilling prophecy.
What does the inverted yield curve mean?
Now let’s talk about that inverted yield curve. An inversion means that short-term borrowing is more costly than long-term borrowing. This can eventually cause panic buying as short-term investors abandon the near-term trade in favor of a long-term trade. With everyone scrambling to buy long-term, traders face a feeding frenzy.
This is not natural. The longer you loan money out, the more you should be compensated via a higher rate.
Back to the “R” word. Recessions are a natural part of a growth economy. It has peaks and valleys, and some are longer than others. Of course, this natural cycle doesn’t stop the media from scaring the bejeezus out of everyone. The recent inverted yield curve is just one in a long line of “crises”.
I’m not worried, and here’s why: The Federal Reserve Bank is paying attention. Since 1980, the Fed has pursued low inflation via monetary tools such as interest rate policy. Cheap money is a sign of a weak economy, and we are certainly not in that situation. I would be scared if the Fed was ignoring signals.
In short, the inverted curve may be an ominous sign to some people, but it’s not a tragic event. After 10 years of growth, maybe the economy is due for a reset.
