Hand stopping falling dominos

Now that the Treasury yield curve has flattened substantially from 2014’s very steep configuration, some economists and other impressionable types are worried about a recession in the next 12 months. They are citing the fact that a flat yield curve has heralded each of the previous recessions. However, they have forgotten one of the first things they learned in statistics class—never confuse correlation with causation. In past cycles, flat yield curves emerged after short-term rates moved sharply higher. In turn, they often pushed up bond yields and mortgage rates enough to create a turndown in the housing sector. That is not happening now.

The following table shows how yield curves behaved prior to the past five recessions:

Glasses laying on financial chart

If you believe what you see in the financial press, with the recent drop in yields, the bond market is suggesting either a slowing in gross domestic product (GDP) growth or a recession. In contrast, the stock market appears to be arguing the opposite. Which is the more likely outlook? Stock prices are included in the index of leading indicators. Bond prices are not, but the slope of the yield curve is included. Meanwhile, Deutsche Bank economists are saying that, because the yield curve is now relatively flat, there is a 60% chance of a recession in the next 12 months. Is the bond market that prescient?

I think the answer is a resounding no! The current super-low bond yields are probably due more to exceptional global factors than signs of weakness in the domestic economy. Almost all the economic indicators that have been reasonably good guides to future activity are quite healthy:

Newspaper chart

Dr. Brian Jacobsen discusses the likelihood of recession here in the United States and strategy to position portfolios.

Todd Crawley: Weakness in the financial markets creates headlines declaring we are recession-bound here in the United States. Are we? I’m Todd Crawley.

Wayne Badorf: And I’m Wayne Badorf.

Todd: And this is The Essential Practice. We are bringing Chief Portfolio Strategist Dr. Jacobsen back to explain yet another headline in the markets today. Brian, welcome back.

Brian: Thanks for having me back.

Wayne: Brian, let’s address the headline question right off the bat.

Brian: Sure.

Todd: Is recession a fear or reality?