In 1996, the New York Federal Reserve did a study on what indicators were the most reliable predictors of a recession. The only one of six indicators that was significantly reliable was an inverted yield curve. They later did a private study with over 20 factors and still the only dependable indicator was the inverted yield curve. I read the studies in 1999. (I later learned of Ph.D dissertation done by the very smart Dr. Harvey Campbell, now a professor at Duke, which pre-dated the Fed study, but came to the same conclusions. The Fed study clearly relied upon his earlier work.)
In a normal world, short term rates are lower than long term rates. This makes sense, as investors want to be compensated for the risk of the longer holding period. There are exceptions to this rule, and at times short terms rates rise above long term rates, giving rise to what is known as an inverted yield curve. Typically, when the yield curve is inverted or negative for 90 days, you get a recession in about 12 months. Actually, it is more than typical. In the US, every time we have had a period of negative yield curves, we have had a recession within a year.Thus, in August of 2000, as the yield curve in the US went negative, I predicted the US would enter a recession in the summer of 2001, and since the stock market loses an average of 43% in a recession, it followed that the stock market would tank. Quite the out of consensus call at the time. Although the NASDAQ was still in a swan dive, the New York Stock Exchange was climbing to within shouting distance of its previous high. The economy seemed to be moving along quite nicely. But the yield curve was staring us right in the face.
John goes on to point out that the US yield curve is flattening, it is nowhere near an inverted yield curve and not signaling a recession. However, he does point to an inverted yield curve in England. So it goes.
