I was clearing some research from my desk, the great clearout during the great lockdown, and came across some notes I have from March 2019 in relation to the inverted US yield curve! There was much talk of the fact that an inversion of the US yield curve had preceded each of the last US recessions, since the early 1950s!

Cambell Harvey’s 1986 dissertation at the University of Chicago showed that an inverted yield curve, where short-term rates are higher than long-term rates, led to a recession within 12-18 months.

The gap between three-month Treasury Bill and the 10-year benchmark Treasury Note is closely watched. An inversion is when the 10-year yields fall below those on three-month bills.

This 3 month Treasury Bill traded above the 10-year benchmark Treasury Note part of the yield curve inverted in March 2019 for the first time since the 2007-2009 financial crisis and remained inverted until October 2019.

A New York Time article on 30 May 2019

The markets were very worried about the impact of the US-China trade war and the prospects of a hard Brexit. There were also concerns that the Fed was behind the curve and moving too slowly to cut interest rates which were seen as increasing the risks of a US recession.

In late January 2020, as the coronavirus spread and concerns lead to a rally in US bonds, the 10-year yield once again fell below three-month Treasury Bill yields.

The signals from the inverted yield curve signals were ignored as the outlook for the US economy was positive, employment continued to grow and it was felt that the Federal Reserve would cut interest rates sufficiently to keep growth positive.

According to Cam Harvey’s model, the economy usually enters recession 12 months after first turning negative. With the initial inversion in March 2019, the model forecast a US recession starting between March 2020 and September 2020, a prophecy which has, unfortunately, come true! Given the yield curves track record on calling turning points in the US economy, it was probably not such a good idea to ignore these signals.