Macroscope | Signs point to a US recession, but when? The answer is, probably not any time soon

Hannah Anderson says that an inverted yield curve means the US should brace for a recession in the medium term, but investors should beware of jumping ship too soon

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Traders work on the floor of the New York Stock Exchange on December 11. Photo: Reuters

Published: 11:00pm, 14 Dec 2018Updated: 10:55am, 15 Dec 2018

Did we just see a concrete harbinger of a future economic recession? That’s what markets have been discussing all week. Movement in the shape of the US Treasury yield curve (a line that plots interest rates and is often used to predict changes in economic output or growth) was the big talking point. The yield curve actually inverted in the middle part, meaning that yields on shorter-maturity bonds were above longer-dated ones.

This happened in part because new information about what we can reasonably expect for the US economy in the short and medium term moved bond prices, shifting the curve. However, shifting investor expectations about the future also affected the curve, resulting in cross-asset market movements.

Although this circular relationship makes it difficult to pinpoint a trigger for shifting expectations, investors were most likely reacting to commentary from the US Federal Reserve.

The Fed signalled to investors that it may grow more accommodating – or tighten monetary policy less quickly – in 2019. While looser monetary conditions would traditionally support risk assets like equities, signals from the Fed that we may be approaching the end of this US business cycle spooked markets, leading to some fears that tighter policy could nudge the already mature US economy into recession.

An economy accelerating in the early part of the business cycle typically offers better returns from risk assets like equities. In the later stages of a cycle, when investors are more worried about the near-term outlook, investors typically want to hold more “safe” assets like bonds.

As prices for those safe assets rise, yields go down (prices and yields move inversely). Differing expectations for two years out versus 10 years ahead mean the yields on two- and 10-year-dated US Treasuries can move in different directions. When markets are more optimistic about the near term than the medium or long term, sometimes the yield on longer-dated bonds moves lower than the yield on short-dated bonds. Hence the phenomenon of yield curve inversion.