The Federal Reserve's Favorite Recession Indicator Is Flashing a Danger Sign Again

The Federal Reserve's favorite recession indicator, the yield curve, is flashing a danger sign once again. The yield curve, which plots the interest rates, bonds, bills, or notes of the same maturity but different issuers or countries, has inverted, signaling a potential recession on the horizon. This inversion occurs when long-term interest rates fall below short-term rates, typically indicating that investors expect economic growth to slow or even contract in the near future.



The yield curve has inverted several times in the past, and each time, a recession has followed within a year or two. The most recent inversion occurred in August 2019, and while a recession did not immediately follow, the U.S. economy entered a recession in February 2020 due to the COVID-19 pandemic. The current inversion, which began in late 2022, is raising concerns among economists and investors alike.



The inverted yield curve is not the only indicator suggesting a potential recession. Other economic indicators, such as the Conference Board's Leading Economic Index and the National Bureau of Economic Research's (NBER) recession dating committee, are also pointing to a possible economic downturn. However, the yield curve inversion is particularly concerning because it is a leading indicator that has historically been highly accurate in predicting recessions.

Investors and market participants are taking notice of the inverted yield curve and the potential recession it signals. Many are adjusting their portfolios to navigate the uncertainty, rotating to safer assets such as long-term Treasury bonds and reducing exposure to riskier assets like equities. Some investors are also employing hedging strategies, such as using options or futures, to protect their portfolios from potential market downturns.



While the inverted yield curve is a cause for concern, it is essential to consider other economic indicators and data points to make a more accurate assessment of the likelihood of a recession. Additionally, investors should remain vigilant and adapt their investment strategies as the economic outlook becomes clearer. By staying informed and adjusting their portfolios accordingly, investors can better position themselves to weather the potential storm that an inverted yield curve and a possible recession may bring.