The Most Accurate Recession Indicator and What It’s Saying Now

A rear view of a concerned businessman as he places his hand on his head and looks up at a U.
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Economists have been warning of a recession for so long it’s hard to remember when they didn’t warn of one. Now there’s another sign that the U.S. economy could be headed for a fall — the U.S. Treasury yield curve.

On Monday, the yield curve moved to its deepest inversion since 1981, Reuters reported. Economists keep a close watch on the yield curve to get signs of potential recession, and when it inverts, the alarm bells go off.

Inverted yield curves happen when bonds with shorter maturity periods have higher yields than bonds with longer maturity periods. Normally, the opposite is true. Because longer-term debt carries greater risk than shorter-term debt, bonds with longer durations naturally have higher yields. This is considered a normal yield curve.

But when shorter-term debt starts producing higher yields, you get an inverted curve — which in the past has been a fairly reliable predictor of economic trouble on the horizon.

Treasuries have been toying with an inverted curve for more than a year, with an inversion having made an appearance as long ago as June 2022. This week, the curve briefly inverted to 42-year lows amid expectations that the Federal Reserve will raise benchmark interest rates at its next meeting.

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“It’s not unusual to get a yield curve inversion but it is unusual to get one of this magnitude,” Brian Jacobsen, senior investment strategist at Allspring Global Investments, told Reuters. “We haven’t seen one like this in quite a while.”

As Reuters noted, investors watch parts of the yield curve as recession indicators — particularly the spread between three-month T-bills and 10-year notes along with two- to 10-year notes. Yields on two-year Treasuries have been above 10-year Treasuries since last July.

These types of trends continue to raise concerns about a looming recession even as the economy overall is in decent shape. Inflation has eased considerably in 2023, though it’s still above the Fed’s target rate of 2%. Unemployment remains near record lows and the GDP continues to grow, albeit slowly.

Technically, a recession is defined by economists as two consecutive months of economic retraction. But on a real-world basis, a recession is a tangible economic slowdown, usually accompanied by job losses and shrinking corporate profitability.

One worrying sign is that corporate profits declined during the 2023 first quarter, according to Trading Economics. However, that’s partly because of tough comparisons to the prior year, when profits moved sharply higher.

In any case, ongoing warnings of a recession have both investors and consumers jittery. Many investors might be tempted to sell their stocks until the risk of a recession passes. But that strategy is “inherently risky” because it’s impossible to accurately time the market, and the current yield curve inversion “could be a false alarm,” Motley Fool reported.

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The best strategy for now is to stay invested until there are clearer signs of a deep and extended slowdown.

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