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So many market participants now regard an inverted yield curve as a harbinger of a recession, due to the indicator’s perfect track record of preceding an economic slowdown. Today, Jack interviews the founder of this economic indicator, Campbell R. Harvey. Harvey shares how he discovered this signal in the bond market in the 1980s, and how it has an 8 out 8 track record in preceding recessions (with zero false signal). An inverted yield curve is when short-term interest rates exceed long-term interest rates. Harvey’s specific signal on which he wrote his dissertation in 1986 (his thesis advisor was Eugene Fama, Nobel Prize-winning economist) was the spread between the 10-year Treasury yield and the 3-month Treasury yield. It is this indicator which has an 8/8 perfect track record, not the 2s10s (10-year Treasury yield minus the 2-year Treasury yield), which as Harvey notes gave a false signal in 1998.
Harvey argues that since his 10-year / 3-month signal inverted in the fall of 2022, the first and second quarter of 2024 is when a potential economic slowdown would occur (the average lag between the inversion of the 10-year / 3-month spread is 12 months, but the longest lag is 22 months). However, Harvey notes that there are several positive forces supporting the U.S. economy, such as fiscal stimulus and a strong labor market, as seen by job vacancies in excess of unemployment. While Harvey hopes that these forces can induce a “soft landing,” it is his base case that the 10-year / 3-month inversion will go 9 for 9 in forecasting an economic slowdown.
Harvey is Professor of Finance at Duke University’s Fuqua School of Business, Research Associate of the National Bureau of Economic Research (NBER), Director of Research and Partner at Research Affiliates, and author of the book “DeFi and the Future of Finance.” Filmed on January 16, 2024.
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Cam Harvey’s Original 1986 Dissertation on Inverted Yield Curve: https://people.duke.edu/~charvey/Research/Thesis/Thesis.pdf
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Timestamps:
(00:00) Introduction
(12:07) Early 2023 Harvey Raised Possibility That "This Might Be A False Signal"
(18:39) VanEck Ad
(19:18) Inverted Curves Go From Predicting Recessions To... Causing Them?
(21:04) The Theoretical Support For Why Inverted Yield Curves Precede Recessions
(25:18) The Impact Of Expectations of Federal Reserve Interest Rate Policy On The Yield Curve
(30:52) Factors That Support A Soft Landing: Tight Labor Market and Strong Housing Market
(36:44) What About The Chance That There Was Already A Recession In 2022?
(42:41) Worries About The Banking System And "A Future Credit Squeeze"
(46:05) Fed Should Cut Rates Right Now, Since Shelter Inflation Data Is Extremely Lagging
(55:04) Closing Thoughts On Yield Curve
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Disclaimer: Nothing discussed on Forward Guidance should be considered as investment advice.
Forward Guidance