This Indicator Normally Points to Recession, But What’s It Telling Us Now?

There are more and more reasons to believe that the US economy is on the verge of recession. But can anyone say with certainty that the economy will enter a recession within the next year? That’s a little more difficult to predict.

After all, the US economy has been on a troublesome trajectory since at least 2019, when the first weakness in overnight funding markets became apparent. It’s been a roller coaster ride since then.

One piece of data that many people like to look at to determine whether a recession is imminent is the yield curve. In most cases that the yield curve inverts, recession follows within months. With the yield curve inverted right now, is a recession on the way?

What Is the Yield Curve?

Interest rates on bonds generally hold to a particular pattern, with short-term interest rates being lower than long-term interest rates. This reflects the growing risk of default that can occur with longer-dated bonds.

If you were to graph interest rates on various maturities of US Treasury securities, you would see the graph sloping upward from left to right, with lower interest rates on short-term T-Bills and higher interest rates on long-term securities. But every now and then that yield curve inverts, with short-term interest rates rising higher than long-term interest rates.

That can happen for a number of reasons, such as when investors prefer to purchase longer-term bonds rather than short-term bonds, driving prices for long-term bonds up and yields down. The yield curve inversion reflects the fact that investors think long-term interest rates will be lower than short-term rates.

Every recession since 1969 has been preceded by a yield curve inversion, and recession usually follows the inversion within months. One of the most common inversions to look at is the spread between two-year and ten-year Treasury bonds. Normally the yield on the 2-year is lower than the yield on the 10-year bond, so the 10-year minus 2-year yield spread is positive. But when the yield curve inverts, that spread turns negative.

Right now the 10-year/2-year yield spread is deeply negative, at about 1 percentage point. That’s the most negative the spread has been since the early 1980s.

Not only that, but the negative yield spread is also at the longest duration it’s been since the early 1980s, at nearly a year. The question everyone has right now is, will the spread continue to deepen and will the yield curve inversion remain prolonged, or will the yield curve un-invert and lead to recession?

How the Yield Curve Could Return to Normal

Right now one of the driving factors behind yield curve inversion is the rising interest rate environment fueled by the Federal Reserve’s monetary policy. With the federal funds rate now at 5.00-5.25%, it’s no surprise that short-term interest rates are rising. But long-term interest rates aren’t anywhere near that level.

Right now the Fed expects to raise interest rates twice more by the end of the year, pushing the federal funds rate to 5.50-5.75%. But if that doesn’t happen, and if the Fed instead cuts rates because of a worsening economic situation, that could bring short-rate interest rates down and lead the yield curve to normalize.

Let’s assume that the economy starts to really enter a downturn over the summer, and the Fed decides to cut the federal funds rate by 50 basis points in September, and then again in its next two meetings. That could push short term interest rates down by over 150 basis points, and could result in the 2-year Treasury bond yield falling as well, possibly below the 10-year bond yield.

It is this loosening cycle that will likely result in the yield curve in the US returning to normal. But no one knows when exactly that will occur. The only thing we can see for certain is that the yield curve is strongly inverted and is signaling that recession is almost certain to occur. And with an inversion that is the strongest we’ve seen since 1980, that brings back bad memories of those days.

Interest rates in the early ‘80s were far higher than they are today, with average 30-year mortgage rates rising to over 18%. Inflation was in double digits, and the economy was still reeling from the stagflation of the 1970s. Is that the type of economy we’re going to see in the future?

One Bright Spot: Precious Metals

Not everything was bleak during those dark days, however. Even the worst of times sometimes features a silver lining, and during the 1970s and early 1980s, that was both a gold and silver lining.

Gold and silver both surged throughout the stagflation of the 1970s, with annualized growth rates of over 30% per year over the course of the decade. They demonstrated how, even in the face of a lackluster economy and high inflation, gold and silver could provide asset growth and wealth preservation.

With the US economy facing a potential return to stagflation during the next recession, particularly if the Federal Reserve has to cut its tightening cycle short, many people are hoping that gold and silver might see similar growth now as they did back then. Even 10% annualized growth rates would be welcome in today’s investing environment.

Decades on from the early 1980s, the options available for buying gold have multiplied. The Gold American Eagle and Silver American Eagle coins were first introduced in 1986, providing US citizens with what are now some of the most popular investment-grade gold and silver coins in the world.

And by the late 1990s, Americans could now start to own these coins in IRAs, giving rise to the popularity of gold and silver IRAs. Twenty-five years after gold and silver IRAs were introduced, they continue to grow in popularity, as they provide an important means of protecting assets in tax-advantaged retirement accounts with physical gold or silver.

Goldco has over a decade of experience helping customers protect their hard-earned money with gold IRAs and silver IRAs. With over $2 billion in precious metals placements and thousands of satisfied customers, call Goldco today to learn more about how a gold or silver IRA could help protect you during a recession and help you reach your financial goals.