Replace Yield Curve as a Recession Predictor? The Fed Considers an Alternative - ABI

Minutes of the Fed’s June policy meeting, released yesterday, revealed that the central bank considered an alternative approach to avoid some of the shortcomings of using bond yields, the New York Times reported. The bond market indicator in question is the yield curve, which tracks the yields on Treasury securities that are repaid after different periods. The yields on the Treasuries that are repaid in two years are usually lower than those that are repaid, or “mature,” in 10. But sometimes, as is now the case, the difference between the yields on two-year and 10-year Treasuries narrows. When that happens, the yield is said to be flattening. This week, the spread between the two bonds was only 0.3 percentage points. But the most alarming signal is sent when the yield curve “inverts.” That is when the yields on two-year Treasuries are higher than those on 10-year Treasuries. When that has happened in the past, recessions have soon followed. But changes in the bond market and economy may have made the yield curve a less useful predictor. The Fed and other central banks bought huge amounts of government securities after the financial crisis, which raised their prices and reduced their yields. Those purchases may still be holding down yields. In addition, investors appear to believe that there is less risk of inflation in the global economy these days, which makes Treasuries more appealing. At the same time, the Fed has been raising short-term interest rates, and is expected to keep doing so through at least next year.

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