The creator of the inverted yield curve, a recession indicator with a decades-long track record of accuracy, said it has evolved beyond just a warning of a future slowdown and now has implications for the economy.
The reversal 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 Duke University finance professor who coined the idea of the inverted yield curve as a leading indicator, He told CNBC on Friday, It has predicted eight of the last eight recessions dating back to the 1960s with no false positives.
That forecast has been glowing for about 20 months, and the absence of a recession during that time has raised doubts about its accuracy. But Harvey said the lead time has historically ranged from six to 23 months.
He added that the inverted yield curve has recently changed to become a “causal mechanism” that could lead to slower economic growth.
“So when people see an inverted yield curve, it changes their behavior. So when you as a CEO see an inverted yield curve, you become less inclined to make a decision to invest in some sort of bet on the farm,” he said.
Harvey said the Fed’s aggressive tightening has caused the yield curve to invert, and it should undo the damage by cutting interest rates sharply as well.
The Fed’s rate hikes certainly helped bring consumer inflation down from 9.1% in mid-2022 to just 2.9% in the latest reading, the lowest annual rate in three years. But in the process, the economy slowed.
Given the inverted yield curve’s strong track record and ability to change behavior, it could also be used to help manage risk, meaning businesses will be prepared if a recession hits later this year or early next, Harvey explained.
Otherwise, a recession that catches companies off guard will force them to cut their employees’ salaries suddenly, exacerbating the economic slowdown.
“So, think of this indicator as an indicator of economic growth actually slowing down, but it leads to a situation where we can see a slowdown without a sharp decline. So, growth will be slower and not something like the global financial crisis,” he added.
Recession fears eased last week after a weak payrolls report initially raised concerns, but worries persist. Gold prices, for example, hit new record highs, partly due to concerns about the economy.
“Black Swan” investor Mark Spitzengel, founder and chief investment officer of private hedge fund Universa Investments, said: luck A recession is coming this year as the biggest market bubble in history will soon burst.
“It’s not different this time, and anyone who says it’s different is really not paying attention,” he said, adding, “The only difference is that the size of this bubble that’s bursting is bigger than we’ve ever seen.”