Talk of recession is rife. Macroeconomic data prints are discouraging, and most all have slashed economic growth projections for 2022 and beyond. Unsurprisingly, market participants are trying to predict if, and when any recession might occur.
One popular and frequently cited go-to metric said to reliably predict recessions is an ‘inverted’ yield curve, i.e., when the spread between the yield of a shorter and a longer duration tenor turns negative (typically the yield of the US nominal 2-year and 10-year Treasury). In short, when the yield on short-term debt increases above that of longer-term debt, recessions are said to follow. In this paper, focusing on the US case, we evaluate this claim using an approach based on fictitious Profit and Loss curves (P&Ls) when ‘trading’ recessions. We also compare the predictability of the yield curve with other contenders.
Our findings can be summarized as follows – inverted yield curves tend to be a good predictor of a recession in one year from the moment of the inversion while a slightly better predictor of recessions comes from the stock market with negative S&P 500 performance preceding recessions with a high level of significance
Read the full report here.