Some investors believe that the warning of a recession that has been flashing on Wall Street for the past several months is wrong and that the Federal Reserve will be able to tame inflation and escape a deep recession.
The signal — called the yield curve — began last year indicating that the economy was heading for a recession. But since then the stock market has rebounded and the economy has remained resilient.
The yield curve describes the line created on a graph when government bond prices of different maturities are arranged in chronological order. Typically, investors expect to pay more interest for lending for longer periods of time, which leads to a downward sloping curve. Last year, the curve reversed, with short-term bond yields rising higher than longer-maturity bonds.
A reversal indicates that investors expect interest rates to decline over time from their current high level. It usually only happens when the economy needs a boost and the Federal Reserve decides to help by cutting interest rates.
However, even though the US economy has slowed, it remains on a solid footing and investors are ready for good news from Tuesday’s inflation report, which is expected to show the Fed’s attempts to slow the pace of price rises.
“This time I tend to underestimate the yield curve,” said Subhadra Rajappa, interest rate analyst at Société Générale.
One common measure of the yield curve is its most inverted in 40 years, with the yield on the two-year note about 1 percentage point higher than the yield on the ten-year note.
The last time the yield curve inverted was in the early 1980s, when the Fed last suffered from hyperinflation, leading to a recession.
It is difficult to predict the exact time between an inversion and a recession from the yield curve, and it has varied widely in the past. However, it has been a fairly reliable indicator for five decades.
But history may not repeat itself this time because the current circumstances are special: the economy is recovering from a pandemic, unemployment is low and businesses and consumers are mostly doing well.
“The situation we’re in is very different from normal,” said Price Doughty, senior portfolio manager at Cite Investment Associates. I don’t think he expects a recession. It is a relief that inflation is declining.”