Markets Are Confusing Correlation With Causation

Now that significant portions of the bond market’s yield curve has inverted, including the part that the Federal Reserve thinks is significant, the race is on to decipher the message being sent. The knee-jerk conclusion is that a recession lies ahead. After all, every recession since the 1950s has been preceded by an inverted yield curve. On the other hand, not all inverted yields curves have led to a recession.

Inversions – which occur when short-term bond yields rise above those on longer-term bonds – don’t cause a recession in and of themselves; rather, they are a signal that bond investors expect a significant slowdown in the economy. And they’re usually right: recessions have typically followed anywhere from six to 24 months later. But what about now? If you think about it, expectations for a recession in the months ahead aren’t new and predate this latest inversion. Back in February, the National Association for Business Economics’ semiannual survey of business economists found that 10 percent saw a recession beginning this year; 42 percent projected one next year; and 25 percent expected a contraction starting in 2021. That’s all within the six to 24 month timeline.