The most reliable warning signs won't flare until a downturn is almost here.
Financial markets freaked out on Aug. 14, when the interest rate on 2-year Treasury securities temporarily fell below the rate on 10-year notes. Long-term rates are normally higher than short-term ones, and when these rates “invert,” it often means a recession is coming. Stocks fell 3% that day.
Measuring the yield curveThe inverted yield curve has a strong record of foretelling a recession. But it’s a long-lead indicator, and different ways of measuring the yield curve are saying different things. The gap between 2-year and 10-year rates is now positive once again, for instance, suggesting no recession is coming.
Another piece of data, the Conference Board’s index of leading economic indicators, is designed to predict turns in the economy—with a strong record of doing so. Capital Economics found that a recession developed every time the LEI, as it’s known, fell by 2% or more, on a year-over-year basis. But the LEI only predicted the onset of recession about a month ahead of time. It’s not at recession levels now, but it could get there in a fairly short period of time.
The New York Federal Reserve puts the odds of a recession within the next 12 months at 38% – and that has risen rapidly in 2019. But that’s based on the gap in interest rates, so if rate spreads are less predictive than they used to be, the New York Fed would be overstating the risk.
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