Here’s a More Reliable “Recession Indicator” Versus an Inverted Yield Curve
“The lead time between past inverted curves and economic contractions is widely variable”
by Bob Stokes
Updated: April 05, 2022
Longer-dated bonds generally yield more than shorter-dated bonds to compensate an investor for assuming the greater risk of tying up money for a longer time.
As examples, 30-year government bonds have historically offered investors a higher yield than 10-year notes, and 10-year notes generally provide a higher yield than 2-year notes.
However, there are times when the yield on a shorter-term bond is higher than a longer-term bond. This is known as an inverted yield curve and many market observers view this occurrence as a signal that a recession may be just around the corner.
For example, a March 28 CNBC headline said:
5-year and 30-year Treasury yields invert for the first time since 2006, fueling recession fears
The next day, on March 29 and then again on April 1, the yield on 2-year U.S. treasury notes climbed above the yield on 10-year U.S. treasury notes -- prompting more potential recession talk. A key reason why is that a yield inversion has preceded every U.S. recession since at least 1955.
However, here are some important insights from our just-published April Elliott Wave Financial Forecast:
The lead time between past inverted curves and economic contractions is widely variable... and usually does not occur until after the curve un-inverts. Since stock prices lead the economy, it is more reliable to monitor equities to estimate when the onset of an economic contraction may occur.
Indeed, here's some historical evidence of that from Robert Prechter's landmark book, The Socionomic Theory of Finance, which says:
It is important to understand that socionomic causality does not predict that each stock market decline will produce an official recession as defined by the National Bureau of Economic Research; it predicts that stock market declines and advances will reliably lead rather than follow whatever official recessions and recoveries do occur.
So, keep an eye on the stock market for a clue about what's ahead for the economy.
You can get fresh Elliott wave analysis of the U.S. stock market by reading our just-published flagship investor package, the Financial Forecast Service, which provides near-, intermediate- and long-term forecasts.
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