This New Yield-Based Recession Indicator Is Flashing Red!It is common knowledge that interest rates play a major role in any economy, so I recently decided to sit down and see how the 10 year U.S. bond yield has acted during recessions in the past to see if it correlates somehow with today's markets. After all, the biggest component of any recession is monetary policy which would imply interest rates and therefore bond yields play a larger role than any other element, and could be viewed of as a leading indicator rather than a lagging indicator.
Obviously as the economy weakens policy makers tend to cut the short end of the yield curve in hopes of stimulating growth and this in turn pulls down interest rates across the entirety of the curve, long end included. As the Federal Reserve raised rates from 2016 until now bond yields trended up, but since the Fed has paused it's tightening cycle the market has been taking matters into its own hands with the 10 year bond yield falling off a cliff since late 2018 down from 3.2% to now a little over 2%. Large drops in the 10 year yield have historically indicated that the market is anticipating weaker growth ahead and have always preceded U.S. recessions.
Knowing this we can take two simple moving averages of the 10 year yield, the 30 week and the 250 week, and plot them against previous recessions to try and accurately ascertain when the next recession is likely to begin. What we see as highlighted by the vertical red lines are that recessions typically begin right as the 30 week moving average crosses down below the 250 week moving average. this indicator perfectly predicted the market top and dot com bust of 2000, the market top and financial crisis of 2008 and it is currently indicating a market top right now as we speak and a subsequent recession beginning by October of this year (2019).
As we all know Recessions are not officially acknowledged or announced until nine months after the beginning of the recession due to lagging official data. So if we do end up entering a recession this October we can expect complete denial from policy makers up until they officially announce it around the end of Q2 2020.
We may likely be in for a very bumpy and volatile period over the next 12 months for equities.
Take a look at my related and linked article below showing how the 3-month treasury yield is predicting that the Fed will slash rates to below the zero lower bound and into negative territory by next year.
This is not financial advice, just some simple economic analysis.
