Fed Chair Questions Value Of Yield Curve For Recession Forecasts

Federal Reserve Chairman Jerome Powell, at his first press conference as the head of the central bank, announced a hike in interest rates. A tighter monetary policy was widely expected. What was surprising was Powell’s comments on the value of the Treasury yield curve as a tool for predicting the next US recession.

Responding to the last question at the press event, Powell said that “it’s true that yield curves have tended to predict recessions if you look back over many cycles.” But the near-flawless record of using an inverted curve – short rates above long rates – no longer applies in the current economic climate, he explained. History, in short, is misleading.

A lot of that was just situations in which inflation was allowed to get out of control and the Fed had to tighten and that put the economy into recession. That’s really not the situation we’re in now.

Powell believes that with inflation holding at relatively low levels, the Treasury yield curve is no longer a reliable signal as an early warning that a new recession is near. Many analysts are sure to disagree. Nonetheless, it’s surprising to hear a sitting Fed chair speak so clearly about a business-cycle indicator that’s been widely studied and embraced for years for estimating recession risk in real time.

Whether you agree with Powell or not, his dismissal of the yield curve deserves attention, in part because the current spread is close to the lowest level since the last recession ended. For example, the difference between the 10-year rate less the 2-year rate is just 58 basis points (as of March 21), which is just slightly above the 51-basis-point mark in January, the lowest since 2007.

Economists point out that the rate spread has dipped into negative terrain just ahead of NBER-defined recessions for decades. By some, perhaps most accounts, the yield curve remains a critical indicator for deciding if a new downturn is a high-probability risk. Based on Powell’s comments, however, it’s reasonable to count the Fed chairman as a skeptic.