Watching the Yield Curve – Recession Ahead?

Lately there has been a great deal of talk about whether the US is headed into a recession, and if so when and how bad it might be. The forecasting world seems to be betting on both sides of this question.

To begin with, the recent indication that the fed is backing off from its previously indicated forward looking rate hikes went a long way in cooling concern from the many Wall Street investors. As J.P. Morgan’s CEO Jamie Dimon was recently reported to have said, “The market was roiled by the Fed rate hikes and escalating trade tensions between China and the US, but that has eased a bit.”.  As it is, the US economy is currently robust. The unemployment rate is at a 48-year-low. “It looks like there will be growth,” Dimon said. “We’re not going into a global recession.”

But there are others taking a different view based on indicators that have proven to be fairly reliable historically. A recent article in Bloomberg reflects the sentiment of Societe General in their February headline stating “U.S. Recession Increasingly Credible to Top-Ranked Strategy Team”. In this story, the experts cite two indicators they track. One is the US Treasury yield curve and the other is based on a sentiment index from news stories.

Let’s focus for a moment on the yield curve question. If you look at the chart below from the federal reserve there seems to be a clear correlation between a flattening or inversion of the yield curve and a subsequent slow down. In this chart the spread between the 10yr and the 2yr is indicated in basis points and the shaded vertical bars are economic slow downs or recessions domestically.

Whether the energy crisis of 1980, the 1990 oil price shock, the 2000 dot com bubble and 9-11, or the still starkly remembered Great Recession beginning 2007, each of these events followed a flattening and some inversion of the yield curve. But yield curve did not alone cause these recessions as each had their own story surrounding the “why” and the “how”, whether it included Paul Volcker’s sharp interest rate rises to slow the inflation of the 1970’s suddenly being impacted by an Iranian revolution and new regime resulting in global instability in oil and more. Or in the early 2000’s after a huge rally in stocks suddenly seeing the bubble burst combined with the 9-11 attack which abruptly threw a roadblock into economic expansion. It was the confluence of factors with the one common element of the yield curve being a key indicator that produced a slowdown or recession.

The bulls argue that this time it’s different. Krishna Memani of Oppenheimer funds thinks we are headed for long term growth. “There’s no recession imminent — I think five more years is what we are talking about,” Krishna told CNBC on January 14. On the other hand the bears make a different case. Moody’s Analytics famed economist Mark Zandi, in an interview I conducted with him recently stated the following, “The good news: The economy is strong enough — with significant job creation, low unemployment and accelerating wage growth — and there is little reason to fear a recession in 2019, assuming assorted complicating factors (the shutdown, the trade war, etc.) are resolved. The bad news: That’s not going to last, especially with the juice provided by the fiscal stimulus fading away. So a recession likely does loom in the future — just likely not until mid- to late 2020”.

No matter what you believe, these indicators have been reliable predictors, but the combination of factors that lead to slowdowns are what matters. Job growth, low unemployment, and more can suddenly be affected by the outcomes of trade wars, global events such as regional conflicts or political upheaval. The key is to be watchful as changes can occur quickly and can lead to short term implications to all in our industry and this nation.

In the meantime, lets keep a watch on the yield curve because no matter what view you get of it, whether the chart above or this one below, the longs seem to be betting on the bears.


Dave Stevens

By David Stevens, Senior Advisor at Mortgage Media

David H. Stevens, CMB, is Senior Advisor at Mortgage Media, and former SVP of Single Family at Freddie Mac, former EVP at Wells Fargo Home Mortgage, former President and COO of the Long and Foster Realty Companies, former Assistant Secretary of Housing and FHA Commissioner, former CEO of the Mortgage Bankers Association