Every day, someone, somewhere cites the yield curve (pick a curve, any curve) to argue that a US recession is a foregone conclusion.

Of course, a recession is always a foregone conclusion unless you think the economy can grow every, single quarter, uninterrupted, forever. The recession question is always about “when,” not “if,” which means that in the event a given curve inversion isn’t followed by a downturn within some reasonably short window, it’s not especially helpful to say the inversion “predicted” the recession.

With that caveat, there’s obviously something to the idea of curve inversions as recession canaries, but let’s not forget that the godfather of curve inversion analysis recently suggested that this time could be different. In a January interview with Bloomberg, Cam Harvey said that despite his curve’s perfect track record, the current inversion may be seen, in hindsight, as a false positive, 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.

But there’s another reason to be wary of the purported “signal” from the curve, and it’s related to the r-star discussion from “Finding The North Star In Oz.”

“The range of views about [the] long run rate is considerably tighter than the distribution around the short rate for the end of next year,” Goldman’s Praveen Korapaty and William Marshall began, in a recent note, calling attention to the “relative stickiness” of long rate views, which “has meant that positive growth and labor market data, which have resulted in the fading of recession odds, and therefore rate cut pricing at shorter horizons, have also produced more inversion in commonly tracked curve measures.”

Do take a moment to internalize that. It means that the deeper the inversion, the lower the recession odds — the “opposite implication than commonly ascribed,” as Korapaty put it. That raises questions about the validity of the market’s anchored assumptions (i.e., the narrow distribution) for long run rates.

I won’t trouble readers with the specifics of Goldman’s modeling exercise, but suffice to say Korapaty and Marshall showed that replacing a commonly used natural rate estimate with the CBO’s potential growth series produces a 2s5s curve that’s almost 40bps less inverted.

What accounts for the disparity? Well, as Korapaty wrote, investors appear to be using a real rate anchor that’s some 150-200bps below real potential GDP growth, consistent with an r-star of 0-50bps. Not coincidentally, that’s the same r-star assumption from the pre-pandemic years, and matches up with the implied real rate from the Fed’s long run dot.

Summarizing, Korapaty and Marshall wrote that their analysis,

Strongly suggests that a large part of the inversion seen in current US yield curves comes not from high recession odds or inflation normalization, but rather from low long run real rate levels. Investors appear to be wedded to the secular stagnation, low r-star view of the world from the last cycle. We believe this cycle is different, with an economy that can support a higher long run real rate than currently assumed.

Readers will politely recall what I wrote Sunday, in the “Oz” article linked above. If r-star is higher than policymakers believe, then current monetary policy isn’t as tight as you’d be inclined to think, which could explain why the only parts of the US economy which seem to be responding to Fed hikes are those which are directly impacted by them.

“If the low r-star view is correct, the Fed’s policy stance would indeed be substantively restrictive, and we will likely have a decidedly worse growth outcome than we currently anticipate,” Korapaty went on to write. “If, on the other hand, our economists’ baseline for a still robust economy comes to pass, it will be hard to argue that the Fed has been severely restrictive.”