This graph makes a lot of people nervous
Why?
It appears to predict that America is about to go into recession
It’s based on an economic indicator called the yield curve
So if you care about the economy, you should probably care about...
...what's going on with the yield curve
That’s Alice Fulwood, The Economist’s Wall Street correspondent
And the reason people get sort of so het up about this...
...is that each time the yield curve has inverted...
...it has immediately preceded a recession in America
In fact only on one occasion in the last 70 years has there been a false alarm
And here’s the thing...
It inverted in March of this year
So what is it about this curve...
...that seems to make it such a good indicator...
...of where the economy is heading?
The line illustrates the return, or yield...
...investors get from investing in government bonds...
...from short-term investments on the left...
...to longer-term ones on the right
Usually the longer the time frame the higher the interest rate...
...as investors demand a bigger return...
...if they’re to lock their money up for longer
However, if investors fear the economy is slowing down...
...then the long-term rates can drop below short-term rates...
...the curve inverts
So when the yield curve inverts something strange is going on
Here’s why
When the outlook is gloomy investors are more likely to buy safe assets...
...like long-term bonds, pushing their price up...
...so the interest rate for holding them falls
Higher bond prices are also a signal...
...that there are fewer exciting investment opportunities elsewhere...
...such as the stockmarket
Of course there are plenty of other indicators you could look at...
...to get a sense of what’s happening to the economy
A lot of people look at the stockmarkets
Survey data—so you can go out and ask businesses what they feel
You can look at consumer behaviour
You could also look at sort of various metal prices like...
...if copper prices are very high
Copper is an industrial metal it implies that...
...lots of manufacturing companies are buying copper to make goods
Then there’s the rate of change in unemployment...
...which correlates closely with recessions
And even monitoring the number of times that newspapers...
...publish the word “recession” can help to anticipate a downturn
But bear in mind that when you’re trying to predict a downturn...
...you’re often trying to get a read on people’s expectations...
...of where the economy is heading...
...which is why that curve is so useful
Everyone invests in the US Treasury market...
...from the Chinese central bank to pension funds in Canada and Europe...
...hedge funds in America
Everyone is exposed to and invests in the US Treasury market
So if you’re looking for an aggregate opinion of everyone in the world...
...what they think might happen to the US economy...
...and by extension the global economy...
...you'd be very hard pressed to find something more important to look at...
...than the Treasury market and the yield curve
But these are extraordinary times for the US economy
Which is always a dangerous thing to say...
...but it really could be different this time
The US economy has undergone a lot of very experimental...
...and sort of extraordinary monetary policy over the last ten years
In particular people highlight quantitative easing
Quantitative easing was a policy followed by the Federal Reserve...
...to stimulate the economy after the 2008 financial crisis
The Treasury bought companies’ debt to reduce long-term interest rates
Some experts believe it’s distorted the yield curve
And some people argue that that means that long-term interest rates...
...can’t quite signal what they used to in the past
They’re no longer this sort of clean...
...look at what investors are thinking about growth and inflation...
...because quantitative easing and that process has sort of...
...systematically or fundamentally changed...
...what long-term interest rates show you
So should investors worry about the inverted yield curve?
While you can debate whether...
...the yield curve inverting in the US in March of this year...
...necessarily means that there will be a recession in the US soon
What you probably can say is that...
...it’s not a great signal that growth next year will be strong
The flattening that’s taken place over the last year...
...suggests that growth should slow from 3% next year to 2%
In other words predicting America’s next recession...
...just got a little harder
But the indicators...
...are starting to flash red