US Yield Curve Inverted Again

We discussed the previous inversion of US yield curve in March 2019 and it predicted accurately the recession in 2020:

Yiu, C.Y. (2019a) Yield Curve is Inverted Today, Medium, Mar 23.

The US Yield Curve is inverted again since Tuesday (12 July 2022) again. Here shows the recent US yield curve spread between 10-year and 2-year maturities. The previous three occasions of inverted yield curve predicted accurately the recessions as shown in the grey periods. Recession seems to be in front of our future.

Figure 1 US Yield Curve Spread. source: FRED

Spillover to the World

Interestingly, the inversion in 1998 did not trigger a recession in the US, but the Asian Financial Crisis in Asia. It is because the inversions were caused by the sharp increase of short term interest rate by the FED. For example, there were a sharp increase of the FED rate from 3% to 6% in 1994, strengthening the US currency exchange rate. The US currency index increased from about 83 in Jan. 1995 to more than 118 in Jan. 2000. It caused money outflows from Asian countries to the US and resulted in foreign debts defaults.

The FED Rate. source: FRED

How to rescue the recessions?

Also, in the previous two inversions, the FED “rescued” the recessions by cutting interest rates and Quantitative Easing (QE), as the inflation rates were relatively low. However, this time, inflation (or stagflation) is aggravating not only in the US, but also in most part of the world. The latest inflation rate of the US in June 2022 is increased to 9.1%! The FED has voiced out the plan to further increase interest rate until inflation can be tamed. In other words, the common tools of expansionary monetary policy to rescue recession may not be available this time, but are working to worsen the recession.

The coming recession may only be solved by either increasing supply (say oil and natural gas) or decreasing demand voluntarily and spontaneously. However, if the Russia-Ukraine war cannot be stopped peacefully soon, supply of oil and natural gas may not be easily increased. Thus, the recession may be lingering for a long period of time as people are usually reluctant to cut their demands. It can take a very long time for the market to adjust (cut) their demands to meet the reduced supplies.

Certainly, there can be other solutions. For example, if we can suddenly invent some methods to increase supply of other sources of fuel, then the recession may be solved easily.



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