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● A usuallyreliableindicator
ofrecessionsmaynotreallybe
predictingone● ByPeterCoy
Thechanceofa recessionin 2020 hasDemocraticcam-
paignstrategistsfeverishwithanticipation—whiletrying
nottoshowit—andPresidentTrumpevenmoreampedup
thanusual.WhileTrumpsayshe’sconfidentofthestrength
oftheU.S.economy,hisactionsindicateotherwise.He’s
demandingthattheFederalReservecutitskeyratetarget
byatleasta fullpercentagepoint,whichwouldbeextra-
neousatbestandoutrightinflationaryatworstif theecon-
omyreallyisrunningstrong.Herecentlydelayedsome
tariffsfromSeptemberuntiljustbeforeChristmastoleave
moremoneyinconsumers’pockets.He’salsomulledtax
cuts,althoughhetoldreportersonAug. 21 thatthey’reoff
thetablefornow.SurelyTrumpis mindfulthatthereelec-
tionbidsofbothJimmyCarterandGeorgeH.W.Bushwere
derailedbyrecessions.
Well,guesswhat,folks?It’sstillrainbowsandpotsofgold
outthere.Contrarytowhatseemstohavebecometheover-
nightconventionalwisdominpolitics,a recessionbefore
ElectionDay 2020 remainsa lessthan50-50proposition.In
a Bloombergsurveyofeconomists,themedianestimateof
theprobabilityofa U.S.recessionwithinthenextyearis 35%.
BackinFebruary,52%ofeconomistssurveyedbytheNational
AssociationforBusinessEconomicsexpecteda recessionby
theendof2020.Inthelatestedition,releasedonAug.19, that
figure was down to 40%.
Far from a downturn, the median forecast for 2020 in
Bloomberg’s survey of economists is for growth of 1.8%,
which is smack within the range that the Fed estimates the
economy can sustain without an acceleration of inflation. If
recession isn’t so likely after all, it means the White House
probably should ease off on emergency measures to boost
growth. And it means the Democrats running for president
need to calibrate their messages for a world in which the
economy remains strong right up to Election Day 2020.
But what about the inversion of the yield curve that your
annoying brother-in-law keeps yammering about? The notion
that the U.S. economic expansion will continue, extending
what’s already the longest growth streak on record, going
back to 1854, seems to fight the news that the famous yield
curve has inverted, with long-term interest rates sinking
below short-term ones. (The reverse of the usual relation-
ship.) Such inversions have been strong indicators of reces-
sions in the past.
The first thing to say is that the famous inversion between
2-year and 10-year Treasuries is over, at least for now, having
lasted all of 2 hours and 15 minutes in the early morning ofAug.14, according to Bloomberg data. A very brief inversion is
less of a recession omen than a long one would be. True, the
inversion between 3-month Treasury bills and 10-year notes
has been in place most of the time since May, but that’s not
as strong an indicator.
The second thing is that any inversion of the yield curve is
a less reliable signal of recession now than it was in the past.
A few words of background on the yield curve in case you’ve
been tuning out your brother-in-law. It’s simply a graph of
interest rates. On the left are short-term rates and on the right
are long-term rates. The graph slopes up to the right when
long-term rates are higher than short-term ones, as they usu-
allyare.Theextraintereston,say,a 30-yearbondcompen-
satesinvestorsfortheriskthatsomethingunpredictablewill
happeninthenext 30 years that damages the bond’s value,
such as a burst of inflation.
But the yield curve has gotten flatter over the past few
decades. So it’s pretty close to sloping downward—i.e., invert-
ing—even on ordinary days when nothing special is happen-
ing. It will invert more often “even if the risk of recession has
not increased at all,” said an economic note published by the
Federal Reserve Bank of Richmond in December.
The upward slope of the yield curve is an artifact of times
past, when the rate of inflation was higher and—importantly—
less predictable than now. Long-term bonds had to offer high
yields to attract investors to compensate for the fact that
they were a poor hedge against the biggest worry of the day,
namely an unexpected spike in inflation. These days, though,
the biggest worry is not inflation but deflation. Bonds hap-
pen to be an excellent hedge against deflation because they
gain in value when interest rates fall.
This is a roundabout way of explaining why the inver-
sion of the yield curve—so famous that even Trump tweets
about it—isn’t as worrisome as it once was. Long-term bonds
have become more useful in reducing the risk in an inves-
tor’s portfolio than they were 40 years ago, so they don’t
have to offer such high yields to attract buyers. As a result,
the famous upward slope of the yield curve has mostly dis-
appeared, and an inversion “is less likely to be a predictor
of recession than it used to be,” says Alexander Wolman,
an economist and vice president at the Richmond Fed who
was the lead author of the bank’s paper on the shape of the
yield curve.
There’s plenty of evidence of U.S. economic strength out-
side the bond market as well. At just 3.7% in July, the unem-
ployment rate is down to levels not seen since the 1960s.
That’s good not only for newly employed workers, who have
been pulled off the sidelines, but also for the businesses that
sell things to them. Consumer spending, the biggest part of
the economy, expanded at an annual rate of 4.3% in the sec-
ond quarter. (It would be even stronger if rich retirees over-
came their fear of spending some of their ample savings,
page 20.) In times past, ultralow unemployment would have
stirred fears of excessive inflation. But the inflation measure
that the Fed pays attention to, the price index for personal