Campbell Harvey, a distinguished Canadian economist and researcher at Duke University, is famous for popularizing the most prominent recession indicator in the market. Through his research, Harvey found that an inverted yield curve, denoting short-term Treasury yields surpassing long-term government bond yields, has consistently preceded US recessions for over five decades.
Having accurately predicted eight out of eight recessions dating back to 1968 with zero false signals, Harvey's recent appearance on the Forward Guidance podcast shed light on his belief that a recession is imminent - most likely occurring in the first or second quarter of this year due to the yield curve inversion in late 2022.
Previously, in January 2023, Harvey had expressed doubts about his indicator's accuracy, considering the robustness of the labor market and other positive economic data. However, he has now reversed his stance.
I had some credibility in saying 'my model could be wrong' because it's my model, Harvey said. Essentially I was saying it might be possible to dodge a recession, but this was really contingent on the Fed standing down — and this is one year ago — so standing down and not hiking rates any further. And that is not what happened.
During the 2022-2023 cycle, the Federal Reserve hiked interest rates a staggering 11 times, leading to a benchmark rate increase from nearly 0% to a range of 5.25%-5.50%.
Consequently, Harvey shifted his outlook, anticipating considerably slower growth in 2024. He emphasized that the inverted yield curve acts as a self-fulfilling prophecy, warning companies and investors of an impending slowdown, which then alters their spending and business behavior, ultimately resulting in decreased economic activity.
It makes the yield curve causal, Harvey said. This causality channel is much different than in the past.
Furthermore, experts note that the inversion itself is not the definitive sign of a recession. Instead, the de-inversion, when long-term yields surpass short-term bond yields again, indicates the onset of a downturn.
Given the indicator's flawless track record, Harvey observed that firms can now make more informed decisions amid the current economic landscape, operating with a heightened sense of caution. Unlike the global financial crisis in 2008, companies are better equipped to manage risks strategically, and he remains hopeful that severe layoffs can be avoided.
Indeed it could come to the point where the indicator could come to the point where the indicator just loses its ability to forecast, he said, but I don't think we're there yet.