Finally...Someone Thinks Inverted Yield Curve Might Mean "Recession"

Ever since the yield curve inverted, back in the summer of 2006, almost every economist and strategist who has commented on the subject (including Ben Bernanke) has calmed fears about this ominous indicator by carefully explaining why this inversion does NOT mean that we're headed into a recession.  In other words, the forecasters have carefully explained why "it's different this time."  Well, finally, one economist--Northern Trust's Paul Kasriel--has had the guts to suggest that the inverted curve might actually means what it usually means.

In the March 16th issue of the eContrarian, Kasriel notes that every recession since the one in 1970 has been preceded by an inverted yield curve and that only once, in the fall of 1998, has the curve inverted without an ensuing recession (and in that case, you may remember, the Fed reacted to the decelerating economy and tanking stock market by slashing the Fed Funds rate 75 basis points--which Kasriel suggests may have forestalled a recession).

Kasriel explains the theory behind the "signalling" effect of the inverted yield curve (a slackening of demand for credit drives down long-term rates) and then shows that demand for credit is indeed slackening.  He notes that economic growth is indeed decelerating.  And then he quietly floats the Occam's Razor hypothesis that most of his economist brethren continue to reject: It might not be different this time.

Comments

[Dylan]

We are always heading into a recession unless we are already in one! The question is, when? Inverted curves, recessions, these things happen. Will we enter recession as the negative spread grows? Once it starts heading toward flat? Will the curve go normal first? How long will any of these events of this take? No one can answer these questions without a crystal ball. These debates are silly at best. How did economists become trusted forecasters anyway? They’re great at reaching consensus about measurements and applying logical interpretations of events, but when it comes to predicting the future, they’re all over the place. Who do you listen to, and what are you actually going to do differently?

If you’ve ever watched an NFL pre-game show, you’ll see four guy’s who know an awful lot about professional football try to pick the game’s winner. Rarely do they all agree and sometimes the majority is wrong. Are you ready to place your bet?

[Henry Blodget]

Another good and fair point. Forecasting is almost always an intellectual exercise rather than a practical one.

On the intellectual side, however, it is always surprising to me how quick experts are to conclude that it's "different this time," instead of "it's probably the same." Having made the former mistake in the 1990s, I'm extra-sensitive to it, but it's still surprising.

[Dylan]

Yes, as you point out, there certainly have been very smart people fooled into believing “this time, it’s different.” However, you shouldn't let that continue to surprise you because, after all, why should this time be any different?

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