- An inverted yield curve has preceded every recession since 1969.
- The inventor of the famous indicator said that he accurately expects a decline this year.
- When the yield curve inverted in November 2022, he said it was the wrong signal.
Wall Street has ramped up its calls for a soft landing for 2024, but a popular economist who popularized the markets’ most popular recession indicator says: We expect deflation this year.
Campbell Harvey is a Canadian economist and researcher at Duke University, whose work has shown that for decades, an inverted yield curve — when yields on short-term Treasury bonds exceed the yield on longer-term government bonds — has been a recession in the United States.
Dating back to 1968, the predictive power of the index is eight out of eight, with no false signals. Harvey told host Jack Farley on Forward guidance podcast on Thursday that given that yields reversed in the fall of 2022, this points to a recession in the first or second quarter of this year.
He had expected in January 2023 that the indicator would turn out to be wrong this time, given the strength of the labor market and other positive economic data. However, he reversed this view.
“I had some credibility in saying that my model might be wrong, because it is my model,” Harvey said. “I was basically saying that it might be possible to avoid a recession, but that was actually conditional on the Fed pulling back — and this is one year ago — so pulling back and not raising interest rates any further. And that’s not what happened.”
The Fed raised interest rates 11 times in the 2022-2023 cycle, raising its benchmark interest rate from around 0% to a range of 5.25%-5.50%.
“As a result, I kind of revised my opinion,” he continued. “Given the circumstances, I think we are likely to see much slower growth in 2024.”
In one sense, he said, an inverted yield curve is a self-fulfilling prophecy because it signals to companies and investors that a slowdown is on the horizon, which then changes spending and business behavior and ultimately leads to less activity.
“It makes the yield curve causal,” Harvey said. “This causal channel is very different from what it was in the past.”
The inversion itself is also not the last call for a recession, as experts note that in fact when the curve steepens and long-term yields exceed short-term bond yields again, it signals that deflation has arrived.
Given its exemplary record, Harvey noted that the index currently allows companies to make smarter decisions in the current landscape and act with more caution. Unlike the global financial crisis in 2008, he said companies have become more strategic and risk-managing, so he hopes there are no major layoffs coming.
“It could actually get to the point where the index loses its predictive power, but I don’t think we’re there yet,” he said.