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Could the Yield Curve’s Inversion Mean a Recession?

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The yield curve and the Fed

The yield curve mainly reflects bond market investors’ expectations of the Fed’s actions and future economic conditions. The current shape of the curve implies that the bond market expects weakness in 2019 accompanied by lower inflation.

As the Fed may hike up short-term rates by another 25 basis points at the December meeting, the yield curve could invert. The Fed has maintained that its future decisions will depend on market data. However, yield curve flattening and inversion could dampen the likelihood of rate hikes.

The yield curve’s significance for the Fed

At the Fed meeting on July 31 and August 1, some Fed officials argued that, in the United States (DIA) (VOO), an inverted yield curve (TLT) (BND) has often preceded recessions. Therefore, policymakers should consider the slope of the yield curve while assessing economic and policy outlooks.

Others suggested that a number of global factors, such as central banks’ asset purchase programs, may have compressed term premiums. They think yield curve inversion is not as significant as it has been in the past.

Yield curve inversion and a possible recession

According to The New York TimesSan Francisco Fed researchers wrote that inversions of the curve have “correctly signaled all nine recessions since 1955 and had only one false positive, in the mid-1960s, when an inversion was followed by an economic slowdown but not an official recession.”

While there is a case to be made about inverted yield curves predicting recessions, market participants are also citing investors’ estimates of rates and the lingering impact of the Fed’s previous asset purchases as possible reasons for the yield curve’s loss of predictive power. Whatever the case may be, as markets grow more concerned about the inverted yield curve and a possible recession, the loop keeps getting stronger. Moreover, many market participants, including big banks, are convinced that there may be just a little upside to the markets left, if at all. Therefore, gold (GLD) (SGOL) and other precious metals could mitigate risks and uncertainty in case of a major slowdown.

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