For the first time ever, China is facing a dreaded prospect: the inverted bond yield curve. The phenomenon, in which long-term interest rates sink below short-term interest rates, has caused some consternation among market-watchers, who know it's traditionally a harbinger of recession. The inversion suggests markets expect interest rates to fall eventually as monetary authorities move to stimulate economic activity.
In other countries, the curve is such a reliable indicator of a downturn that the Cleveland Federal Reserve maintains a recession probability measure based on short- and long-term government bond prices. The bank writes that bond yields “predict whether future GDP growth will be above or below average," although it acknowledges that the measure "does not do so well in predicting an actual number, especially in the case of recessions.” In other words, bond yields provide good evidence about the direction of economic growth, if not specific levels.