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   Investment Thoughts - Macro Observations

Information in the Yield Curve about Future Recessions
"Furthermore, when interpreting the yield curve evidence, one should keep in mind the adage “correlation is not causation.”

 

Abstract

 

The ability of the Treasury yield curve to predict future recessions has recently received a great deal of public attention. An inversion of the yield curve—when short-term interest rates are higher than long-term rates—has been a reliable predictor of recessions. The difference between ten-year and three-month Treasury rates is the most useful term spread for forecasting recessions—without any adjustment for an estimate of the underlying term premium. However, such correlations in the data do not identify cause and effect, which complicates their interpretation.

 

 

Text Excerpt:


"Furthermore, when interpreting the yield curve evidence, one should keep in mind the adage “correlation is not causation.” Specifically, the predictive relationship of the term spread does not tell us much about the fundamental causes of recessions or even the direction of causation. On the one hand, yield curve inversions could cause future recessions because short-term rates are elevated and tight monetary policy is slowing down the economy. On the other hand, investors’ expectations of a future economic downturn could cause strong demand for safe, long-term Treasury bonds, pushing down long-term rates and thus causing an inversion of the yield curve. Historically, the causation may well have gone both ways. Great caution is therefore warranted in interpreting the predictive evidence."

 

 

Chart Excerpt:

 

 

 

 

Publication link

 

 


 

Reprinted from the Federal Reserve Bank of San Francisco’s Economic Letter, 2018-20, August 27, 2018. The opinions expressed in this article do not necessarily reflect the views of the management of the Federal Reserve Bank of San Francisco or of the Board of Governors of the Federal Reserve System.

 

 

 

Federal Reserve Bank of San Francisco, Economic Letter, August 27, 2018-Michael D. Bauer and Thomas M. Mertens

01.09.2018


 

Themes

 

Asia

Bonds

Bubbles and Crashes

Business Cycles
Central Banks

China

Commodities
Contrarian

Corporates

Creative Destruction
Credit Crunch

Currencies

Current Account

Deflation
Depression 

Equity
Europe
Financial Crisis
Fiscal Policy

Germany

Gloom and Doom
Gold

Government Debt

Historical Patterns

Household Debt
Inflation

Interest Rates

Japan

Market Timing

Misperceptions

Monetary Policy
Oil
Panics
Permabears
PIIGS
Predictions

Productivity
Real Estate

Seasonality

Sovereign Bonds
Systemic Risk

Switzerland

Tail Risk

Technology

Tipping Point
Trade Balance

U.S.A.
Uncertainty

Valuations

Yield