Why the Currently Inverted Yield Curve Isn't Triggering a Recession

For 70 years, an inverted yield curve has been followed by a recession. Mitch looks at why this doesn’t appear to be happening in this cycle. [Mitch on the Markets] Why the Inverted Yield Curve Hasn’t Led to a Recession in this Cycle Over the past 70+ years, nearly every U.S. recession has been preceded by an inverted yield curve. Historically, any time the yield curve inverted for a period of at least two months, a recession followed within the next 18 months.1 The chart below makes this relationship clear – the red circles indicate yield curve inversions, and the gray bars show the recessions that followed. Readers can see how closely the two have correlated historically. Recessions Historically Follow Yield Curve Inversions [MOTM_03022024_graph1]( Source: Federal Reserve Bank of St. Louis 2 The current cycle, however, appears to be playing out differently. The yield curve – as measured by the difference between the yield on the 10-year U.S. Treasury bond and the 3-month U.S. Treasury bond – first inverted in October 2022, and since then the U.S. economy has not only continued expanding but also accelerated in some periods. --------------------------------------------------------------- [Download Our March 2024 Stock Market Outlook Report]( The U.S. economy has averted recession for now, but the longer the yield curve is inverted the higher the chance that bank lending activity could start feeling negative impact. To keep up with the latest trend of the yield curve as well as ever-shifting economic fundamentals, I recommend keeping an eye on reliable, up-to-date data to ensure your portfolio is allocated appropriately. So today, I’m offering our [March 2024 Stock Market Outlook]( which provides detailed insights, such as: - The Importance of Asset Allocation - Zacks Rank S&P 500 sector picks - Current asset allocation guidelines - Zacks forecasts for the months ahead - Zacks Rank industry tables - And much more! If you have $500,000 or more to invest and want ideas on how to invest in a strong market, click on the link below to get your free report today! [IT’S FREE. Download the March 2024 Stock Market Outlook 3]( --------------------------------------------------------------- Before digging into this disconnect, it’s important to understand the yield curve in terms of its impact on credit—which is the fuel that keeps the economy humming. When the yield curve is upward sloping, it means short-term borrowing rates are lower than long-term lending rates for banks, which creates positive net interest margins and makes it profitable to lend. When the yield curve is inverted, however, the opposite is true – banks have to borrow at high short-term rates, which creates profitability issues with lending and tighter credit conditions for the economy. When credit and lending activity dries up, economic activity tends to follow. In the current cycle, however, higher short-term rates have not had a major impact on bank profitability or lending activity over the past year. The reason: banks are still flush with deposits. Deposits at Commercial Banks Surged After the Pandemic and Remain at High Levels [MOTM_03022024_graph2]( Source: Federal Reserve Bank of St. Louis 4 In a sense, the Fed’s aggressive rate hike campaign did not put banks in the unwelcome position of having to borrow at increasingly higher short-term rates. Banks had – and continue to have – plenty of cash on hand. To be fair, deposit rates have started going up at banks recently, and increased competition for deposits could become an impediment to bank profitability. But in my view, the Fed is likely to start cutting rates before that becomes a concern. In the meantime, credit has been flowing in the U.S. economy. Recent declines in long-duration Treasury yields have led to a surge in investment-grade corporate bond issuance, which is running at a record pace so far in 2024. And despite worries that last year’s regional bank stress would cut off major sources of lending, banks have been loosening lending standards in recent months. In the chart below, the percentage of banks tightening lending standards for mid-size and large business commercial loans (blue line), loans to small firms (red line), and auto loans to consumers (green line) have all fallen. The Net Percentage of Banks Tightening Lending Standards Has Fallen Recently [MOTM_03022024_graph3]( Source: Federal Reserve Bank of St. Louis 5 Bottom Line for Investors Consumers have already taken falling, long-duration interest rates as a prompt to increase their borrowing. Mortgage applications are up, and we’ve seen much higher issuance of asset-backed securities – which are bonds backed by debt like credit cards and auto loans – rising materially in 2024. The yield curve inversion will eventually unwind, but the key question looking forward will be how that happens. The Fed could start cutting rates later this year to bring the short end of the curve lower over time, while the economy continues to expand. This would in turn give banks additional options for lending, and we could see even more meaningful increases to credit flowing in the economy – a harbinger for more growth ahead. If you’re looking for more insight into what’s next for the market, I recommend downloading our [March 2024 Stock Market Outlook Report 6]( which contains some of our key forecasts to consider, such as: - The Importance of Asset Allocation - Zacks Rank S&P 500 sector picks - Current asset allocation guidelines - Zacks forecasts for the months ahead - Zacks Rank industry tables - And much more! If you have $500,000 or more to invest and want to learn more about our market forecasts for 2024, click on the link below to get your free report today! [Claim Your Free Report]( About Zacks Investment Management Zacks Investment Management was born out of one of the country’s largest providers of independent research, Zacks Investment Research. Our independent research capabilities from our parent company truly distinguish us from other wealth management firms - our strategies are derived from research and innovation, including the proprietary Zacks Rank stock selection model, earnings surprise and estimate revision factors. At Zacks Investment Management, we work with clients with $500,000 or more to invest, and we use this independent research, 35+ years of investment management experience, and tools we’ve developed to design customized investment portfolios based on each client’s individual needs. The end result is investment management that is research driven, results oriented and client focused. [Mitch on the Markets] Talk to a Zacks Wealth Advisor today. [Schedule Your Chat]( [facebook]( [linkedin]( [twitter]( © Zacks Investment Management | [Privacy Policy]( 1[Wall Street Journal. February 14, 2024.]( 2[Fred Economic Data. 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