Duke Professor Campbell Harvey, an expert on the yield curve and how its inversion has served as a past precursor of recessions, warned that the yield curve’s un-inversion in recent weeks should not be considered an “all clear” sign. A recession may still be on the horizon, he told Business Insider.
A negative spread between the three-month and 10-year Treasury yields—known as a yield-curve inversion—has precluded each of the seven economic recessions since 1950.
Harvey’s 1986 thesis found that when short-term rates were higher than long-term rates, recessions followed. Since his thesis was published, the yield curve has inverted three times—1989, 2000, and 2006—correctly predicting the three recessions of 1990-1991, 2001, and 2007-2009.
Harvey said that, although the inverted yield curve model is simple, he is aware there will sometimes be “false signals.” However, he suggests this shouldn’t detract from the metric’s past success at predicting economic downturns.
Recession fears began in August after the Dow Jones fell more than 800 points when the 10-year Treasury yield broke the two-year rate for the first time since 2005. The yield curve uninverted on October 11.
According to the Business Insider, one of the arguments against the inverted yield curve as recession signal is that the Federal Reserve’s unprecedented stimulus efforts have altered how economic cycles play out.
Harvey said he isn’t convinced how big a role the Fed may play in economic cycles, but he noted that the government-bond market is so large today and that the Fed’s influence is “greatly exaggerated.”
Harvey said in the report that investors should be cautious of the latest warning because “it’s inevitable that there’s a business cycle,” noting the U.S. is currently in its longest expansion on record.
“One thing that’s very important is that my model links the slope of the yield curve to economic growth or future economic growth,” Harvey said. “And frankly, whether the yield curve’s flat or slightly upward sloping or inverted, all that means the same thing. It means low growth.”
“The inverted yield curve historically suggests future recessionary conditions within approximately 18-24 months,” said Ed Delgado, President and CEO of Five Star Global. “This, combined with global trade tensions, means the industry must remain alert and proactive in preparation for a possible future downturn.”
The Council of Foreign Relations forecasted earlier this month that a recession could occur as soon as the 2020 Presidential Election.
The report references the years preceding the 2008 financial crisis, which saw a rising gap in the growth in home prices and household income, and a “parallel dynamic is playing out” today.
“In 2018, as in 2005, housing-price growth began falling rapidly, with significant price drops occurring in several major markets … The trend-line in existing-home sales growth has also been down since 2015, tipping into negative territory at the start of last year. Similar drops have preceded nearly every recession since 1970,” the report states.
In BuildFax’s September Housing Health Report, Jonathan Kanarek, COO, BuildFax noted that the housing market is beating expectations, even with the threat of recession.
“Amidst concerns of a recession, it’s promising to see the housing market responding to the impact of mortgage rate decreases and other positive moves in the market,” he added. “If housing continues showing the promise of growth, or even a leveling off, this activity has the potential to stimulate the larger economy.”