Does this line predict America’s next recession? | The Economist

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  Does this line predict America’s next recession? | The Economist

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