Mitch's Mailbox

June 5th, 2024

The Yield Curve Has Been Inverted For A While. Where’s The Recession?

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Andrew T. from Nashville, TN asks: Hello Mitch, I can recall from some of your previous writings that an inverted yield curve has usually been an accurate recession predictor. But I’ve noticed recently that the yield curve has been inverted for a long time with no sign of recession. What changed this time around?

Mitch’s Response:

Thanks for sending your question, Andrew. You’re absolutely correct—the yield curve, which measures the difference in yield between short-duration U.S. Treasuries and long-duration Treasuries, has historically been a reliable recession indicator. The chart below shows the 3-month/10-year U.S. Treasury bond yield curve going back to 1980. The red circles show yield curve inversions and the gray bars show recessions. The correlation between the two is evident and shows up if we go back even further in history to the previous eight downturns.1

Source: Federal Reserve Bank of St. Louis2

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Since 1968, it has taken anywhere from 9 to 24 months after a yield curve inversion for a recession to take hold. In the current cycle, the yield curve inversion enters its 24th month in June, with no sign of recession in the United States. Employers continue to add new jobs every month, consumer spending remains strong, wages are rising, and inflation appears to be anchored around 3%. Corporate earnings also continue surprising to the upside.

There is no simple explanation for why a recession hasn’t followed the current yield curve inversion. One reason I’ve floated is that the economy and U.S. corporations are already flush with cash—bolstered by strong economic growth, strong earnings, and trillions of pandemic stimulus dollars. Given that an inverted yield curve tends to compress bank net interest margins, we would expect lending activity to decline—which could dampen economic activity and trigger a downturn. A cash-rich economy, on the other hand, may not feel the impact of softening bank lending as much as it has historically.

Another possible explanation is that a recession is in the offing, it’s just taking longer to materialize in this cycle. That’s quite possible, but it’s not something I’m seeing in 2024. I think we’re likely to get a rate cut from the Fed sometime later this year before a recession is evident. That could lead to a decline in short-term Treasury yields and a flattening of the yield curve, perhaps deeming the inversion indicator moot by early-to-mid next year.

If there’s a lesson to take away here, it’s that relying on a single indicator to predict U.S. economic activity is not sufficient. The U.S. economy is vast and complex, and simply cannot be explained by the bond market alone.

Although the future is unpredictable, there are ways investors can navigate through the economy’s ups and downs. I recommend downloading our free guide, “Helping You Manage Market Volatility4, which offers expert guidance on how to keep a steady course in a turbulent market. You’ll get answers to questions, such as:

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• Can volatility actually be an opportunity?

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Disclosure

1 Wall Street Journal. May 28, 2024. https://www.wsj.com/finance/investing/wall-streets-favorite-recession-indicator-is-in-a-slump-of-its-own-ee885cb9?mod=investing_trendingnow_article_pos1

2 Fred Economic Data. June 3, 2024. https://fred.stlouisfed.org/series/T10Y3M

3 ZIM may amend or rescind the guide “Helping You Manage Market Volatility” for any reason and at ZIM’s discretion.

4 ZIM may amend or rescind the guide “Helping You Manage Market Volatility” for any reason and at ZIM’s discretion.

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