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A key indicator of a recession flashed a warning light two years ago. That metric once had a perfect record, but there hasn't been a crash yet. Our colleagues at The Indicator From Planet Money, Darian Woods and Adrian Ma, explain what is going on with the inverted yield curve.
DARIAN WOODS, BYLINE: The pioneer of the inverted yield curve, Campbell Harvey, explains that yields basically just mean interest rates. And the yield curve represents the set of different interest rates for locking your money away for different periods of time.
CAMPBELL HARVEY: The usual situation is that if you lock your money up for a longer period of time, you get rewarded for that with a higher interest rate, and that's the way it is usually in normal situations. But every so often, it goes the other way, and the short rates increase. And we call this an inverted yield curve.
ADRIAN MA, BYLINE: The key indicator Campbell looks for is does the yield curve stay inverted for a full quarter? And, yes, that happened last year.
WOODS: And so, going by history, this should have meant a recession was around the corner. The longest gap between the first inversion and a recession was in the lead-up to the Great Recession of 2008-2009. That was a 23-month lead-up period. We recently passed that milestone.
HARVEY: Yeah, right now it's officially at the maximum. This is something that we haven't seen historically, and we don't have a recession.
MA: The inverted yield curve does have solid economic theory behind it. When the economy is likely to have a lot of growth in the future, investors want higher interest rates on their U.S. Treasury bonds. When there's concern there's a recession coming, they don't demand as high interest rates for that predicted future.
WOODS: Trillions of dollars are at stake in the Treasury market, so people are really motivated to find the best forecast. The yield curve sums up all of those concerns like this gigantic financial brain.
MA: But according to Campbell, this giant brain might not be as accurate as it once was. I mean, the very fact that people like us at the Indicator are talking about the yield curve so much might change its predictive power. Think about early last year, when it seemed like every tech company was downsizing.
HARVEY: People see that the yield curve is inverted. They change their behavior. This decreases investment. It decreases economic growth. But it's also risk management, and it decreases the chance that we actually go into a serious recession.
MA: And Campbell also adds, we should never rely on just one indicator.
HARVEY: The inverted yield curve is just one piece of this giant puzzle of the U.S. economy. And it's naive to think that that is sufficient information to forecast what's going to happen in the U.S. economy. So obviously, the yield curve will give a false signal. Maybe it's this time. Maybe it's next time. But it's inevitable that there will be false signals from a simple model. So yes, you need to look at other data in the economy.
WOODS: So whether it's jobs numbers, consumer confidence or even vibes on the street, we will be keeping our microphones out, listening for changes in the winds of the swirling U.S. economy.
MA: Adrian Ma.
WOODS: Darian Woods, NPR News.
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