Ed Yardeni, President of Yardeni Research, underscored the inversion of the yield curve of US Treasuries as a precursor of a recession. The bad omen has defied expectations so far. Indeed, the inversion of the 2-year and 10-year Treasury yields has been recorded for more than a year. Still, a recession has not been acknowledged in the US economy yet.
Ed Yardeni reckons that the inverted yield curve indicates there are preconditions for an economic change but does not recognize a slowdown as such. The economist presented his economic standpoint in 2019 in the article The yield curve: what is it really predicting?
In this research, Ed Yardeni took notice of a decline in the key sectors of the US economy, in particular, the housing market and retail sales. The expert admitted that the indicator has proven only 50% true because the US economy has evaded a full-blown recession. As the US economy is driven by consumption activity, consumers have shifted their focus away from buying merchandise to buying services.
At present, the US economy is on a sound footing and is capable of evading a recession despite the inverted yield curve. The yield of 2-year US Treasuries has been firmly stuck above the yield of 10-year Treasuries.
Under steady economic conditions, Treasuries with long-term maturity generate higher yields as investors gain handsome returns in the distant future. However, in the case of the inversion, short-term yields exceed long-term yields because investors expect the Federal Reserve to lower interest rates as a countermeasure against a looming recession.
"What the yield curve does is it anticipates that, if the Fed continues to raise interest rates, something will break in the financial system, and that will quickly become an economy-wide credit crunch, as the credit crunches that really cause the recessions," he said. The analyst pinpoints the reason why a recession has not hit the economy yet. The Federal Reserve provided liquidity to banks to prevent the crisis from spiraling further.