“Ask the yield curve” is a common reply when it comes to questions about whether the US economy is headed for recession.
Typically, if you’re the one asking and your interlocutor hits you with the yield curve rejoinder, it’s sarcastic derision. Not at the yield curve, but rather at you for not knowing the answer to your own question.
The implication: If the yield curve’s inverted, then of course a recession is coming. Everyone knows that. The yield curve is infallible.
From there, though, the discussion gets considerably more complicated. And the self-assured arrogance of yield curve acolytes evaporates in fairly short order when you start asking for nuance. Which yield curve? How long is the lag between inversion and recession? What definition of recession are we using? And so on.
Spoiler alert: Nobody can answer all of those questions, and if we’re all being totally honest, the sample size isn’t large enough to draw statistically significant conclusions. A because recessions do occur from time to time, there’s a very real sense in which the statement “Yield curve inversions always precede recessions” is a tautology.
I wouldn’t want to trouble readers with too much in the way of mental gymnastics, so I’ll extricate myself from semantics and logic and get straight to the point: Cam Harvey, godfather of yield-curve-as-recession-canary analysis, thinks this time might be different. Happily, part of his rationale harkens to much of what I’ve written about the invisible impact of expectations and the extent to which we often forget our own role in shaping economic and market realities.
This is a case where I wouldn’t want to discourage, in any way, readers from perusing the original — Bloomberg got an interview with Harvey and you should read it here.
In the interest of not stealing any thunder from that piece, I’ll simply paraphrase Harvey, who said that despite his curve’s perfect track record, the current inversion may be seen, in hindsight, as a false positive. That’s in part because the idea of the yield curve as an infallible recession indicator is now so thoroughly socialized that inversions could prompt preemptive action on the part of the C-suite and everyday Americans, which could ultimately have the effect of forestalling a downturn.
In addition, the huge number of open jobs across the US economy — nearly 10.5 million on the last business day of November, according to the latest JOLTS figures released on Wednesday — means laid off workers aren’t likely to be unemployed for long assuming they want new jobs. Further, the concentration of layoffs in the tech sector may also be a mitigating factor given that those workers are highly skilled and thus very likely to be picked up by someone, somewhere for something.
“When you put all this together it suggests we could dodge the bullet,” Harvey told Liz McCormick. And with that, I’ll again encourage you to read the original, linked above.
I like to think of yield curve inversion as a necessary but not sufficient condition. Add to that credit spread widening plus some sort of external shock. We have 2/3, credit spreads need to widen….
Ps- some credit spreads have widened, low rated junk, stressed sovereigns, and mortgage rates. Splitting hairs but you could add a decline in corporate profits but that has a high correlation to credit spreads. Corporate IG bond spreads have not widened much to ust bonds yet. We are not quite there yet
Thanks for flagging that article for us. Reminds me of another one you flagged (I believe) a while back by Ben Hunt of Epsilon Theory on the common knowledge game, that he related via his small flock of sheep. I believe that was the same year I discovered you — turns out that was a good year for my brain.
One thing I have been looking at is the tax brackets for 2023, which will increase (over 2022) and be raised, based on 2022 CPI of about 7%. The tables don’t come out until February- but when that happens, the after-tax take home pay will go up and either the savings rate will go up (it has recently declined a lot) or consumer spending will be fueled.
Also note the 2017 TCJA will sunset in coming years. https://taxfoundation.org/look-ahead-expiring-tax-provisions/ is a good look at this. Broadly speaking, I think effective tax rates will go up for many higher income individuals and for some smaller businesses, although the bulk of the sunsets will take place in 2025-2026. I don’t know if the macro effect will be significant. The lower corporate tax rate will not sunset.
Here are a few examples- obviously there are more tax brackets:
The 10% bracket is applicable to earned income under $10, 275 in 2022. That gets bumped to $11,000 in 2023. (This is for an individual. Double the amount for MFJ).
The 22% bracket for income up to $41,775 (individual in 2022) bumps to $44,775 in 2023.
The 32% bracket was for income over $170,050 (individual in 2022) bumps to $182,100 in 2023.
So you can earn 7% more earned income in 2023 (vs. 2022) without bumping up to a higher tax bracket.
“That’s in part because the idea of the yield curve as an infallible recession indicator is now so thoroughly socialized that inversions could prompt preemptive action on the part of the C-suite and everyday Americans, which could ultimately have the effect of forestalling a downturn”
I thought the opposite logic may be true, in the sense that if people expect a recession to arrive, their cutting back on consumption and investment may be even more likely to cause that recession which they feared.