The big story recently was about the yield curve, which inverted on the 10-2 Year Treasury Yield Spread spread recently for the first time since 2007. That was right before the Great Recession hit, and historically has meant a recession would soon follow. We don’t really fear recessions as most people do. They are as much psychologically driven than anything, behavior patterns change with the thought of the ‘evil’ R word. People spend less, and in an economy driven 70% by the consumer then it becomes a self-fulfilling prophecy.
Nobody wants to relive that time, right? But As much as the economy will boom, the economy has bust periods, too. It is not hard to see that economic growth can stall for a bit or even be driven too hot at times. A yield curve inversion simply means that borrowing shorter term is more costly than the long term. That is unnatural on the risk curve, and eventually causes more demand (panic buying) on the long end of the curve as short term investors abandon the near term trade.
The yield curve represents varying degrees of risk vs time. The longer you loan money out, the more you should be compensated via a higher rate. When the curve inverts, the opposite happens. The short end becomes less expensive as rates rise.
Recessions are a natural part of a growth economy. We have peaks and valleys, some are longer than others. We get used to the journey up or down rather than the destination. Sometimes the economy grows too hot and inflation becomes a risk.
Since 1980 our central bank (the Fed) have been targeting low inflation, and for nearly 40 years that has been the case. They use monetary tools such as interest rate policy as a blunt instrument against inflation. Cheap money is a sign of a weak economy, and one of the Fed’s mandates is to foster an environment of stable prices.
The media is making a huge deal of the inverted yield curve. It gets attention, headlines and worries everyone who listens. There is nothing to fear, it’s a part of the business cycle. What would be awful is if the Fed were NOT paying attention to the signals and responding in kind.
So, the inverted curve may be an ominous sign to some, but to us it’s not a tragic event. The economy WILL grow again, but it needs a reset. We’ll have more recessions, we’ll have booms, too. But after this long 10 year cycle, maybe the economy is due for a rest after chugging along steadily.