In America, recessions typically follow after the yield curve has inverted. The relationship seems murkier in other countries but it is tangible
growth and yield curves as a curious case of American exceptionalism. In general, interest rates rise as borrowing periods get longer, because the risks of default and rising inflation grow over time. But occasionally this pattern reverses, and short-term rates exceed long-term ones.
There are good reasons why yield-curve inversions tend to precede recessions. At the short end, when central banks raise rates, the curve flattens and the economy slows. On the long side, when a recession looms, investors expect that central banks will cut rates to soften the blow. That lowers long-term yields, flattening the curve.
The yield curve’s failure to foresee recessions outside the United States has led some scholars to dismiss its predictive power as a fluke. With so few recessions in America, there is insufficient evidence to determine the strength of the relationship. Seen through this lens, America is not an outlier. In 15 of 17 countries, changes in spreads correlated with changes in growth the next year. Overall, a one-percentage-point move in spreads predicted a 0.55-point change in growth in the same direction. The effect was strongest in Switzerland, at 1.1 points; America ranked third.
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