Rule No. 1 of analyzing the economy 📋

The professor who made the inverted yield curve famous nails it 🎯

(Source: Wikimedia Commons)

Don’t count on the signal of a single metric.

That’s rule No. 1 of analyzing the economy using data.

Economic forecasters over-indexing to metrics like the yield curve and the Conference Board’s Leading Economic Index have learned this lesson the hard way: These once reliable predictors of recessions have failed to do so in recent years.

I bring this up today because The Wall Street Journal just published a big feature on the yield curve titled, “Wall Street’s Favorite Recession Indicator Is in a Slump of Its Own.“ The title speaks for itself.

In a nutshell, this indicator has been based on the notion that the economy is functioning normally when long-term interest rates are higher than short-term interest rates, a phenomenon that’s also referred to as an upward-sloping yield curve. When the yield curve inverts (i.e., when long-term interest rates are lower than short-term interest rates), the economy is thought to be malfunctioning. Historically, yield curve inversions have a pretty good track record of preceding recessions.

The inverted yield curve has been predicting a recession that has yet to come. (Source: The Wall Street Journal)

But nothing is ever certain.

And in the current economic cycle, the yield curve — which has been inverted for two years — has been predicting a recession that hasn’t come and doesn’t seem to be coming anytime soon.

The other metrics may tell a different story 📋

My favorite part of the Journal’s feature was this quote from Duke University finance professor Campbell Harvey, who popularized the link between inverted yield curves and recessions:

“It is naive to think that you can just forecast the complex U.S. economy with a single measure from the bond market.”

Harvey nails it.