The inverted yield curve — a recession indicator with a decades-long track record of accuracy — is no longer a warning of a future downturn but is now influencing the economy, according to its creator.
The inversion occurs when long-term bond yields fall below short-term bond yields, an anomaly that has historically occurred when investors see more growth risk in the near future and demand a higher premium.
Campbell Harvey, a finance professor at Duke University who coined the idea of the inverted yield curve as a leading indicator, told CNBC on Friday that she has predicted eight of the last eight recessions dating back to the 1960s, with no false positives.
It has been on the blink for about 20 months, and the continued lack of a recession in that time has raised doubts about its accuracy. But Harvey said the lead time has historically ranged from six to 23 months.
Meanwhile, the inverted yield curve has recently turned into a “causal mechanism” that can slow economic growth, he added.
“So people see an inverted yield curve, it changes their behavior,” he said. “So if you, as a CEO, see an inverted yield curve, you are less likely to pull the trigger on a bet-the-farm investment.”
The aggressive tightening by the Federal Reserve caused the yield curve to invert and must undo the damage by also aggressively cutting rates, Harvey said.
To be fair, the Fed’s rate hikes have helped push consumer inflation down from 9.1% in mid-2022 to just 2.9% at last reading, the lowest annual rate in three years. But in the meantime the economy has cooled down.
Given the inverted yield curve’s strong track record and ability to change behavior, it can also be used to help manage risk, meaning companies will be ready if a recession hits later this year or early next year, explains Harvey out.
Otherwise, a recession that catches companies off guard will force them to suddenly cut their labor costs, worsening the downturn.
“So think of this indicator as an actual slowdown in economic growth, but leading to a situation where we could experience a recession without a hard landing,” he added. “So slower growth instead of something like the global financial crisis.”
Recession fears eased last week after a weak payroll report initially set off alarm bells, but concerns persist. For example, the price of gold has reached new record highs, partly due to concerns about the economy.
And ‘Black Swan’ investor Mark Spitznagel, founder and CIO of private hedge fund Universa Investments, told Fortune that a recession is coming this year, because the largest market bubble in history will soon burst.
“This time is no different, and anyone who says it is is really not paying attention,” he said, adding: “The only difference is that the size of this bubble bursting is greater than we have ever seen.”
