Although investors do not have a crystal ball, certain economic metrics can help investors and business owners make informed decisions on the direction of the economy. For instance, leading economic indicators can signal changes in the economy before they occur. One of the most well-known leading economic indicators is the Yield Curve, which conveys the relationship between short-term and long-term interest rates on treasury bonds.
Financial experts argue that the slope of the yield curve can predict future economic activity. In a normal economic landscape, the curve is upward sloping with the short-term rate lower than the long-term. To understand why, it is useful to think about treasury bonds as essentially investors lending money to the U.S. government. As the maturity of a bond increases, investors expect to be compensated for the increased risk of lending their money over a longer period. Th is relationship between short-term and long-term rates can change, however, with the curve flattening and even inverting. Short-term rates are primarily influenced by expectations of the Fed’s monetary policy, while long-term rates are set by investor’s outlook on inflation and economic growth. A normal, upward sloping curve indicate investors predict future economic health and market expansion. When investors start to anticipate the economy slowing down in the future, this curve inverts with short-term bonds yielding higher than long term bonds. This yield curve inversion signals investors have a pessimistic long-term economic outlook and are willing to pay a premium on shorter term bonds.
Traditionally, economists look at the difference between the three-month and the 10-year Treasury note to determine the possibility of a future recession. Economists pay attention to this metric because it has reliably predicted the last eight recessions consecutively, including the Great Recession of 2008.1 As of June 23, 2022, the spread between the three-month and the 10-year Treasury has remained positive. The spread of the two-year and 10-year Treasury note, on the other hand, does not have a perfect track record of predicting a recession, but is still significant, nonetheless. This inversion historically has predicted seven out of the eight past recessions and has had one false positive in 1994.2 On April 1, 2022, we briefly saw the two-year Treasury note top the 10-year Treasury note at 2.44% versus 2.38%, signaling to investors another recession may be impending. It is important to remember that a recession does not follow immediately after an inversion. On average, a recession comes 19 months after the two-year and 10-year yield inversion.3
With all of this in mind, we believe that we remain at a crucial turning point in the economy as the Fed embarks on aggressive monetary
policies to combat inflation. Here at Moran Wealth Management, we are actively watching for changes in leading economic indicators including
the yield curve and encourage you to reach out to us regarding any questions or concerns.
You may contact us at your own convenience on our mainline 239-920-4440 or schedule an appointment at moranwm.com.
Donald E. Drury President
P: (239) 920.4448
F: (239) 431.5239
5801 Pelican Bay Boulevard, Suite 110, Naples, FL 34108
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