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Virtually Useless?

Updated: Aug 28, 2019

What comes first, the chicken or the yield curve inversion?


We've heard over and over again that an inverted yield curve is a sign of a coming recession. It may have a correlation, but so might the opposite.


It might not be anymore a sign of recession than a recession is a sign of a future inverted yield curve.


The whole idea of the 'recession warning' provided by a yield curve inversion started with a dissertation by (now) economics professor Campbell Harvey at Duke University. That dissertation was written in1986 and has been followed by research from other prominent economists.


It is considered accurate in forecasting a future recession, even though it has been observed in only a handful of cases. In many respects, it's almost virtually useless.

Why? See the chart.


Notice that a recession is always followed by a future yield curve inversion. It depends on perspective and where you begin your observation.

Another observation... Sometimes, the yield curve inverts twice before a recession. In that case could one argue that the first inversion didn't signal a recession? Well, you could say the recession came, eventually, but you can always say that.


How about periodicity? How long after the inversion should we expect a recession (or vice versa)? - They state the average is 22 months from inversion to recession?

22 months? Are you saying we'll likely enter a recession in a couple of years? Just how useful is that?


Virtually Useless...


What's more useful? - The S&P 500 is up, on average, 12% one year after a 2-10 inversion. - It’s not until about 18 months after an inversion when the stock market usually turns and posts negative returns.

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