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Conflicting signs of US recession risk

10/7/2019

The inversion of the yield curve has historically been a reliable leading indicator of recessions in the US. This point has received extensive media coverage in recent months, when bond yields dropped below short term rates. However, years of unconventional monetary policy may very well bias the yield curve signal, so other indicators should be analysed as well. The Conference Board’s index of leading indicators is an obvious candidate. It does not yet point to a near-term recession risk.

TRANSCRIPT // Conflicting signs of US recession risk : October 2019

CHART OF THE MONTH

François Doux:

Is it possible to predict a recession, especially in the United States? That is the subject of our Chart of the Month, with William De Vijlder.

Hello.

William De Vijlder:

Hello François

François Doux:

William, in our economic textbooks, I remember that the inversion of the yield curve was always presented as an early warning sign of recession.

Your chart confirms this somewhat, but today we are beginning to have doubts.

William De Vijlder:

That’s right. Economic history has been marked by a series of inversions and recessions, the one following the other. Today, or rather this summer, we have seen an inversion. So now what?

The problem with this analysis is that the “yield curve” signal is biased. It is biased by the very accommodative monetary policies of the central banks, in particular the Fed and the ECB. This has pushed down long-term rates worldwide. It has triggered a pre-mature flattening of the yield curve. As a result, the signal is now a bit biased.

François Doux:

Can other indicators help us?

William De Vijlder:

If the signal seems to be biased somewhat, then we must look at other factors. Topping the list is the Conference Board index of leading indicators. This composite indicator can be broken down into 10 individual series.

François Doux:

It comprises 10 individual series, one of which is the inversion of the yield curve. This is a rather broad indicator, but how well does it function in retrospect?

William De Vijlder:

It functions well. This can be attributed to the fact that it covers a broad range of indicators. Certain series are taken from the financial markets, such as the slope of the yield curve or the equity markets. It also incorporates the real sphere: household confidence, corporate order books, and the job market. This is what makes the indicator so robust.

In the past, it has never given a wrong signal. What is a wrong signal? It is when a series declines, but recession does not follow. That’s a problem.

François Doux:

And where do things stand today, William?

William De Vijlder:

So far, the series has not declined. In the past, a cyclical downturn was followed by recession. We are not there at all.

As long as we see opposing signals, between this indicator – which is still “going strong” – and the yield curve inversion, we can remain rather calm, although we must still be vigilant. When the indicator does decline, of course, the yield curve will already be inverted. At that moment, things will not be looking good for the US economy. But we are not there yet.

François Doux:

We will continue to monitor the Conference Board’s index of leading economic indicators.

Thank you, William De Vijlder. We will be back in a moment with François Faure and Three Questions on Argentina, which is not doing so well.

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