May 30, 2019

The yield curve inversion is beginning to look a lot like 2006

In this illustration, two hands draw parallel yield curves that rise and fall in opposite directions.

Illustration: Lazaro Gamio/Axios

The difference between the yield on 10-year Treasury notes went further below the yield on 3-month bills Wednesday. The difference is the most since 2007 and suggests that the inverted yield curve may not be going away.

Why it matters: Since the 1970s, an inverted yield curve has preceded every U.S. recession. However, economists, fund managers and other experts have been waving off the inversion's importance so far this year in a way that's eerily familiar.

What they said before: When the yield curve inverted in January 2006, in much the way it has this year, former Fed Chair Ben Bernanke said not to worry. "In previous episodes when an inverted yield curve was followed by recession, the level of interest rates was quite high, consistent with considerable financial restraint," he said in a speech in March 2006. "This time, both short- and long-term interest rates — in nominal and real terms — are relatively low by historical standards."

  • Bernanke's predecessor, Alan Greenspan, labeled it a false indicator, noting that long-term yields were being held down by heavy investor demand, just as they are now.
  • The Wall Street Journal's Greg Ip wrote in January 2006 that it was foreign buying of U.S. bonds and exceptionally low yields on U.S. Treasuries (then about 4%, compared to today's yields which are closer to 2%) that was causing the inversion.

Yes, but: It wasn't just 2006 when experts were certain things were different this time.

  • "We said the same thing in 2000," Bank of America trading strategist Gerald Lucas quipped to the FT in January 2006, while noting that "the inversion was the result of scarcity value at the long end of the curve to do with Treasury buybacks."

Be smart: The experts also insisted that economic data was strong and the usual recession warnings signs — other than the inverting yield curve — simply weren't there.

  • "I think it sometimes portends a recession, sometimes not," said Marshall E. Blume, a finance and management professor at the University of Pennsylvania's Wharton School. This time, it probably does not, he added in 2006.
  • "All the forecasts are quite favorable. There aren’t any real excesses in the economy at the current time."

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