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Using Yield Curve Inversion as a Recession Indicator

August 26th, 2020 by 
PK

We've looked at extending our measure of the United States yield curve back in time. To recap, a yield curve inversion occurs when short-term debt yields higher than long-term debt. That is, the market judges the near-term riskier than long-term.

Since the late 1960s, this phenomenon has been a reliable indicator of a looming recession. For longer time periods... it's been little more than noise. It has been decent lately, though - it's your call on whether to promote it as a reliable indicator.

Recession Since 1871 in the United States vs. The Yield Curve

Since 1871, the National Bureau of Economic Research recognizes 29 completed business cycles - putting us in the 30th for this selected data. For all 29 recessions, we counted the number of months between a yield curve inversion. We looked at 10 year Treasuries and the difference with either our 3-6month borrowing proxy or the 2 Year Treasury. An inversion in either was counted as an 'alarm'.

The Inversion column is the number of months before the recession began that we saw one of these alarms.

Recession NameDurationLengthInversion (Months Previous)
Panic of 1873/Long DepressionOct 1873 –
Mar 1879
5 years
5 months
17
1882–85 recessionMar 1882 –
May 1885
3 years
2 months
21
1887–88 recessionMar 1887 –
April 1888
1 year
1 month
9
1890–91 recessionJuly 1890 –
May 1891
10 months14
Panic of 1893Jan 1893 –
June 1894
1 year
5 months
6
Panic of 1896Dec 1895 –
June 1897
1 year
6 months
2
1899–1900 recessionJune 1899 –
Dec 1900
1 year
6 months
5
1902–04 recessionSep 1902 –Aug 19041 year
11 months
20
Panic of 1907May 1907 –
June 1908
1 year
1 month
24
Panic of 1910–1911Jan 1910 –
Jan 1912
2 years5
Recession of 1913–1914Jan 1913–Dec 19141 year
11 months
7
Post-World War I recessionAug 1918 –
March 1919
7 months13
Depression of 1920–21Jan 1920 –
July 1921
1 year
6 months
3
1923–24 recessionMay 1923 –
June 1924
1 year
2 months
4
1926–27 recessionOct 1926 –
Nov 1927
1 year
1 month
4
Great DepressionAug 1929-Mar 19333 years
7 months
22
Recession of 1937–1938May 1937-June 19381 year
1 month
90
Recession of 1945Feb 1945-Oct 19458 months183
Recession of 1949Nov 1948-Oct 194911 months228
Recession of 1953July 1953-May 195410 months284
Recession of 1958Aug 1957-April 19588 months333
Recession of 1960–61Apr 1960-Feb 196110 months390
Recession of 1969–70Dec 1969-Nov 197011 months3
1973–75 recessionNov 1973-Mar 19751 year
4 months
7
1980 recessionJan 1980-July 19806 months15
1981–1982 recessionJuly 1981-Nov 19821 year
4 months
10
Early 1990s recession in the United StatesJuly 1990-Mar 19918 months6
Early 2000s recessionMar 2001-Nov 20018 months9
Great RecessionDec 2007-June 20091 year
6 months
9

In essence the last column was the warning indicator and the length of time before the recession actually began. Taking the Great Recession as an example, the yield curve last inverted 9 months earlier in May 2007. That month, the 10 Year Treasury averaged a yield of 4.75% while the 2 Year Treasury yielded slightly more.

(Note that we only have 2 year yields back to 1976. If that particular intermediate term borrowing series could be extended back maybe we would clean up after the Great Depression.)

Yield Curve Inversions: An Unreliable Recession Indicator

While the yield curve inversion indicator has been useful over the last 2 generations, its record before that time is... not great.

10 Year Treasury Yield v. Short Term Debt, 1871 - Today
10 Year Treasury Yield v. Short Term Debt, 1871 - Today

Repeating our chart from our last post, you can see even see the difference starting with the Recession of 1969 - 1970.

Before that, the Great Depression broke the indicator for an entire generation. By our indicator, the curve inverted in January 1930, righting again in March. It didn't invert again until September of 1966. Meanwhile, during that time NBER recognizes 7 recessions including the Great Depression.

Inauspicious! You'd probably be better off looking for a better indicator.

For one idea, take a spin through Jesse Livermore of Philosophical Economics's post on the unemployment rate trend versus recessions.

Methodology on the Yield Curve Versus

Our methodology on this post was generally the same as in the previous.

Inside the spreadsheet we added Robert Shiller's S&P 500 Index estimates back to 1871 (but haven't [yet] done anything with them). We also added FRED's shortcut US Treasury 10Y-2Y yield difference.

After that, it's all about the counting. You can find our work here:

short_term_2y_10y_interest_trend

If you use the short term rate proxy, please credit us as Don't Quit Your Day Job... (with the ellipsis). The proper credits for the rest of the series are included in the spreadsheet.

Don't Quit Your Day Job...

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