US recessions have been preceded by an inverted yield curve – when short-term rates rise above those of longer maturities – since the late 1960s. Fast forward to 2023, that’s exactly what happened. happened with the Treasury yield curve over the last month and a half. Still, Harvey asserts that this time around the US economy will manage to avoid a real slump, even if it will continue to slow down a little longer.
“My yield curve indicator has turned red, and it’s been 8 to 8 in predicting recessions since 1968 — with no false alarms,” said Harvey, now a professor at the University’s Fuqua School of Business. Duke, in an interview Tuesday. , however, that it flashes a false signal.
The spread between three-month rates and 10-year yields fell to nearly one minus one percentage point last month, from 234 basis points in May 2022. The spread, on which Harvey’s work are based, has been constantly reversed since mid-2020. November and was hovering around minus 82 basis points on Wednesday.
Although the curve is inverted for the ninth time since 1968, Harvey said it’s probably not a harbinger of a recession.
One reason is the fact that the yield curve-growth relationship has become so well known and widely covered in popular media that it now has an impact on behavior, he said. This awareness prompts businesses and consumers to take risk-mitigating measures, such as increasing savings and avoiding large investment projects, which bodes well for the economy.
Another boost to the economy comes from labor markets, where the current excess demand for labor means laid-off workers are likely to find new positions faster than usual. Also, he said, given that the largest job cuts so far have been in the tech sector, these recently laid-off highly skilled workers are also not likely to remain unemployed. long time.
“Dodge the Bullet”
Harvey’s model was tied to inflation-adjusted returns and he said the fact that inflation expectations are inverted – meaning traders see price pressures easing over time – mitigates also the chances of a coming recession.
“When you put it all together, it suggests we might be dodging the bullet,” Harvey said. “Avoid the hard landing – the recession – and achieve slow growth or minor negative growth. If a recession comes, it will be mild.”
The level of real yields also casts doubt on the recession signal. Inflation-adjusted US 10-year yields are likely to be much higher than the corresponding three-month ones. Although there is no break-even three-month rate, cross-checking the last annual CPI reading with one-year breakevens would yield a negative real rate for the duration, relative to real 10-year returns above 1.5%.
Harvey’s point of view is not unanimous. Many Wall Street firms are calling for a recession this year or early in 2024 following the Federal Reserve’s most aggressive hike in decades to tame inflation.
Former Fed Chairman Alan Greenspan said on Tuesday that a recession in the United States was “the most likely outcome”, a view also shared by former New York Fed Chairman, William Dudley.
If the American economy manages to avoid recession, for Harvey, this will not mean that his model is now demystified.
“In science, we use models all the time, and they’re simplifications of reality,” he said. “And part of the skill of being a scientist is knowing when to deploy the model and when not to or, in other words, knowing the limits of the model. And maybe I’m in a good position to know the limits , since it is my model.
A wild card, he said, is if the Fed, after being late to raise rates last year, turns out to push them too high.
Last month, Fed officials raised interest rates by half a percentage point, bringing their benchmark back to a target range of 4.25% to 4.5%. The quarterly forecast also released indicated that rates would end next year at 5.1%, according to their median forecast, with no rate cut until 2024.
Fed policymakers at their meeting last month also affirmed their determination to bring inflation down, according to the minutes of their December meeting. Meeting 13-14 posted Wednesday.
“I think now is the time to end the crunch,” Harvey said.
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