“I’ve always struggled with the fascination with inversion, because the curve inversion really tells us that rates are about to peak”, SocGen’s Kit Juckes writes on Tuesday, adding that “that there is usually a recession a year or so after Fed Funds have peaked, isn’t exactly earth-shattering.”
No, it’s not. And as Bloomberg’s Mark Cudmore illustrated rather poignantly on Monday, if what you’re looking for is an infallible recession indicator from the curve, what you should be doing is “wait[ing] for the curve to invert by 25bps and subsequently re-steepen to +50bps.”
“That may be data mining, but it’s no different than all the people who are getting excited by the arbitrary decision that an inversion of [the 3M-10Y] matters”, he went on to write, on the way to dryly noting that if you follow his signal (as mentioned above) “you have a 100% accuracy of recession over past 35 years, with no false positives and with an average lead time of 4 months for the three recessions.”
The point is, sure, the yield curve is a useful indicator when it comes to recession timing. And no, it shouldn’t be completely ignored. But really, you could say the same thing about any number of “indicators” and on top of that, you can slice and dice the curve inversion story any way you want to slice it when it comes to deriving the “best” signal.
What’s pretty clearly happened over the past four months (i.e., since the panic over the 2s5s and 3s5s inversions in December) is that the financial news/social media echo chamber has amplified things to the point where every Joe E*trader (that’s just a fun, slightly derisive nickname I ascribe to retail) thinks they need to be an economist and every buysider is made to believe that somehow they need to try and factor in the “signal from the curve” (Charlie McElligott would probably argue that they do, but that’s a more nuanced discussion).
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As Bonds Find ‘Best Friends’, Stocks Grapple With Inversion Freakout
Fata Morgana: Financial Parallax And Recession As Subverted Perspective
Well, if you ask Goldman, you probably shouldn’t panic in the aftermath of Friday’s 3M-10Y inversion. In the latest edition of their GOAL Kickstart series, the bank begins by noting that it’s rare for the 3M-10Y to invert without the 2s10s.
(Goldman)
Next, they remind you that the character of the current episode is somewhat anomalous. “In the last 4 cycles bear flattening has driven curve inversion, while this time the curve have bull flattened”, they go on to say, adding the obvious, which is that this has been driven by overseas “spillovers”, whether that means growth scares from abroad (which is what we got on Friday), the signaling effect from bunds and JGBs, demand for relatively “juicy” yields stateside versus paltry yields in NIRP locales, etc.
“As a result, the curve inversion signal could be less powerful for recessions than in the past since long dated yields across regions have become more correlated”, Goldman continues, before reiterating what everyone else has been keen to pound the table on this week in the interest of allaying fears – namely that this takes time to develop even you do “like” the signal.
“For example in the last 2 cycles, a recession started more than 2 years after the curve inversion date (based on 10y-2y spread)”, the bank adds, on the way to observing that if you look at “the proportion of the curve inversion across different maturities, the inversion degree is still quite weak compared to the last 4 recessions where more than 70% of the curve was inverted.”
(Goldman)
Finally, they include the usual reference to the notion that equity weakness starts to manifest itself when steepening shows up. “Since the mid-1980s, significant drawdowns began only when term slope started steepening after being inverted”, Goldman concludes.
In any event, none of this is going to keep folks from writing breathlessly about inversions and the extent to which what happened on Friday does or doesn’t presage the end of days. So, I suppose the above is just food for thought.
Inversions are a useful indicator that monetary policy is tight. It is a necessary condition, the sufficient condition is spread widening. The analysts citing subsequent steepening should tell you that is the Wiley Coyote moment when the central bank and the market realize that a recession is nigh and steepen the curve by bidding up the front end. Often the curve will then flatten again as players reach out the curve for yield. And thus it goes…..
spread widening= credit spread widening
A level of inversion gets everyone’s attention as it should. The inevitable steepening is wracked with subject criteria thus explaining the lag time to these recessions. Not the least of the subjective criteria is the level of current credibility in the system. Currently I speculate that level is pretty close to an all time low . Everything we discuss in these post indicates that guess to be correct. Expect a lot of confusion injected by the Fed and the power behind the scenes to obfuscate reality thus denying the seemingly obvious…..