Just like the “death cross” in stocks, the inverted yield curve is the bond market’s version of the Grim Reaper when it comes to forecasting a recession. However, outside the capital markets in the United States, the indicator is less reliable.
The inverted yield curve occurs when the yield for long-term debt issues are lower than those of short-term debt issues of the same grade. As stock markets were getting roiled by the tornados of volatility the last few months, the possibility of an inverted yield curve was a growing concern.
On December 3, the yield curve inverted for the first time this year since the Great Recession of 2008 as the yield on the 5-year note hit 2.83, while the yield on the 3-year note touched 2.84. The inversion was even more apparent on December 4 when the yield on the 3-year note was 2.81 and the 5-year note was 2.79.
An inverted yield curve preceded recessions in 1981, 1991, 2000, and the Great Recession of 2008. With concerns of a global economic slowdown, how accurate is this indicator when it comes to economies outside the United States?
“The predictive power of the yield curve outside the United States is very flimsy at best as there are other factors at play such as heavy pension fund demand in the United Kingdom and safe-haven bid for German debt in episodes of euro zone political crisis,” said Kaspar Hense, a portfolio manager at BlueBay Asset Management.