The bond market is flashing a warning sign of a recession on the way. A number of prominent economists aren’t necessarily buying that portent.
We’re talking, of course, about the yield curve inversion. There was a second major inversion this week—that’s where the two-year Treasury has a higher yield than the benchmark 10-year note. Last week, it briefly inverted, then snapped back. This development comes on top of the 10-year’s inversion with the three-month T-bill since May. And yield curve inversions usually signal a recession is coming.
But Nobel laurate Robert Shiller isn’t concerned. He shrugs off the importance of an inversion and says recessions are more likely the result of crowd psychology—in this case, a downbeat public outlook.
Downturns of the economy and the stock market often are a “self-fulfilling prophecy,” Shiller, a Yale professor, said on CNBC. “I hear so much talk about a market correction, it might make it happen.”
“It is a well-known leading indicator,” he went on, referring to the curve inversion. “But I’m not as confident in it as others are.” A curve inversion has occurred before each of the seven recessions since 1969, plus one that a recession didn’t follow. Shiller said that was too small a data set to be conclusive.
Meanwhile, Ed Yardeni, head of Yardeni Research, declared that “inverted yield curves do not cause recessions.” One theory on why an inversion might actually trigger a recession is that bankers will tighten credit availability if the money they pay for deposits (influenced to a degree by short-term rates in the bond market) is higher than what they earn on long-term loans (where long-term bond yields are influential).
All that the inverted curve has predicted in the past, Yardeni wrote in his newsletter, “are credit crunches caused by Fed tightening.” And yet, he goes on to point out, “credit remains amply available.” Indeed, the Federal Reserve just lowered short-term rates by a quarter-point, so nobody is tightening.
“That a flat or inverted yield curve causes banks to stop lending doesn’t make much sense,” he argued. Banks’ net interest margin, the difference between what they pay for deposits and charge for loans, is positive and has been for decades, he added. As of this year’s first quarter, the margin was 3.42%, up slightly from the year-before period, 3.32%, according to the Federal Deposit Insurance Corp.
And Mohamed El-Erian, the celebrated economist for financial giant Allianz, has argued that outside forces are messing up the yield curve as an indicator. “The bond market is distorted. It is distorted by what’s happening outside the US,” he said on CNBC, referring to negative interest rates in Europe. This has led to foreign money crowding into the 10-year Treasury, boosting its price and thus artificially lowering its yield.
Former Federal Reserve Chair Janet Yellen made a similar argument on Fox Business, doubting that the nation is headed for a recession, although she saw some troubling signs, presumably the weakness in the American manufacturing sector.
Still, the yield curve is not a good gauge, Yellen, an economist, contended that there are “a number of factors other than market expectations about the future path of interest rates that are pushing down long-term yields.”