Pavlov And Why One Bank Thinks This Time Is In Fact ‘Different’

Pavlov And Why One Bank Thinks This Time Is In Fact ‘Different’

Reams have been written over the past six months about whether "this time is different" when it comes to a flattening/inverted yield curve presaging recession. Generally speaking, people who engage in this debate fall into one of two camps. Those who insist the yield curve "must be respected" often rely on superficial allusions to historical precedent. The strength of that argument lies not in nuance or analytical brilliance, but rather in the fact that historically, inversions "predict" recess
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2 thoughts on “Pavlov And Why One Bank Thinks This Time Is In Fact ‘Different’

  1. A ton of digital ink has been spilled on this topic. A flat yield curve generally makes it harder for banks to lend, as banks are a vehicle to transform to bridge the gap between short term assets and longer term liabilities. In other words in a world of flat curves it is harder to make spread and therefore profits for a bank or other lender. A flat or inverted curve also suggests that investors believe inflation will be lower and thus are willing to lend at low rates in order to lock in yields. Such a dynamic is often a precursor to a recession, but is only a necessary condition. The sufficient condition is widening credit spreads- that is an increasing aversion to risk. When combined with a flat curve that will cause lending to be curtailed and is then transmitted into the real economy. Many times I find the discussions about this overly technical which makes the concept way harder to understand. Credit and lending is critical to a growing economy. Conditions which cause lending and risk taking to drop will directly lead to a slowing economic growth and if the magnitude of the drop is enough will cause a recession. Thinking of lending as blood flowing through an organism to keep it alive is an apt anology. Cut of the blood flow and the organism begins to decline…..

  2. PS- Credit spreads widened out in the 4q 2018 and if the Fed had not changed course this would have led to a recession. Credit spreads came in after the pivot. This is part of what economists call financial conditions. Watch credit spreads, if they start to widen again it will be a sign of trouble. Likewise if the curve does not change and credit spreads do not widen a recession is unlikely.

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