Chart: Yield Curve Remains Inverted as Recession-Predicting Power is Debated

Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity*

The yield curve is a graphical representation of interest rates on debts for a range of maturities. Typically, it compares the yields on short-term and long-term Treasury securities. The most commonly analyzed yield curve is the difference between the 10-year Treasury note and the 2-year Treasury note, often referred to as the 10-year minus 2-year yield spread. The yield curve chart at the top of this post is for the period from June 1976 to June 2024.

In normal economic conditions, the yield curve is upward sloping, meaning long-term interest rates are higher than short-term rates. This configuration reflects investor expectations of future growth and inflation. However, the yield curve can sometimes invert, with short-term rates exceeding long-term rates. An inverted yield curve has historically been a reliable predictor of recessions.

Yield Curve as a Recession Indicator

The yield curve’s predictive power lies in its reflection of investor sentiment. When the curve inverts, it indicates that investors expect slower economic growth or even a contraction. This sentiment often leads to reduced borrowing and spending, which can trigger a recession.

Historically, an inverted yield curve has preceded every U.S. recession since the 1950s, though the lead time can vary. This is visually evident in the chart above, with grey-shaded recession periods following yield curve inversions. For instance, the yield curve inverted in late 2005, two years before the Great Recession began in December 2007. Similarly, it inverted in 2019, before the COVID-19 induced recession of 2020. Despite these precedents, it’s essential to note that not every inversion immediately leads to a recession, and other economic factors also play significant roles.

Recent Trends in the Yield Curve

In recent years, the yield curve has shown some concerning trends. For instance, it inverted briefly in 2019, causing widespread discussion among economists and investors. This inversion occurred amid trade tensions between the U.S. and China and concerns over global economic growth. The recession that followed in 2020 was primarily due to the COVID-19 pandemic, highlighting that while the yield curve inversion was a warning signal, it wasn’t the sole cause.

Post-pandemic, the yield curve steepened significantly as the Federal Reserve implemented aggressive monetary policies to support the economy. However, as inflation surged in 2021 and 2022, the Federal Reserve began raising interest rates to curb price pressures. This tightening cycle led to another inversion of the yield curve in late 2022 and early 2023, reigniting debates about the likelihood of a recession.

What the Current Yield Curve Indicates

As of mid-2024, the yield curve remains inverted. The 10-year Treasury yield is lower than the 2-year yield, signaling that investors might be expecting an economic slowdown or a potential recession. This inversion comes amidst ongoing concerns about inflation, geopolitical tensions, and the impacts of tighter monetary policies.

However, some argue that the yield curve’s predictive power may be less reliable in the current context. Factors such as unprecedented monetary interventions by central banks, changes in global investment flows, and structural shifts in the economy could be influencing the yield curve differently than in the past. Navigating today’s economic landscape is akin to steering a ship through uncharted waters; what once worked in a familiar river may not apply to the vast and unpredictable ocean we now face. The past couple of years have been unique, to put it lightly, and that may matter. Just as you wouldn’t use a driver for a chip shot in golf, traditional indicators like the yield curve might need to be reevaluated or supplemented with new tools in this evolving economic environment.

Potential Impacts of a Recession on Commercial Real Estate

A recession can significantly impact the commercial real estate (CRE) sector, often resulting in decreased demand for office, retail, and industrial spaces. During economic downturns, businesses tend to cut costs, which can lead to downsizing or closures. This contraction reduces the need for office spaces, leading to higher vacancy rates and putting downward pressure on rental prices. Landlords may struggle to find tenants, and existing tenants might renegotiate lease terms or seek rent reductions.

Miami, known for its dynamic and diverse economy, might face unique challenges and opportunities in such a scenario. The city’s strong ties to international business and tourism could cushion some of the blow, as global companies and tourists continue to see Miami as a key destination. However, if a recession were to severely impact travel and global trade, Miami’s office spaces could see higher vacancy rates similar to other major cities.

Retail real estate is particularly vulnerable during recessions. Reduced consumer spending can lead to lower sales for retailers, forcing some to close stores or declare bankruptcy. This decline in retail activity can create vacant spaces in shopping centers and malls, further exacerbating the financial strain on property owners. The rise of e-commerce, accelerated by the pandemic, has already challenged traditional retail spaces, and a recession could intensify these challenges.

In Miami, the retail sector’s resilience may hinge on its appeal as a tourism hub. High foot traffic from tourists can help sustain retail activity even when local consumer spending declines. Yet, if a recession leads to a significant drop in tourism, Miami’s retail spaces could suffer similarly to those in other regions. The city’s luxury retail market, which caters to affluent visitors and residents, might also experience shifts in demand, potentially mitigating some negative impacts or exacerbating them depending on economic conditions.

Industrial real estate, including warehouses and distribution centers, might be less impacted compared to office and retail spaces. However, a recession can still affect this sector by slowing down manufacturing activities and reducing demand for storage and logistics facilities. While e-commerce has boosted demand for industrial spaces, a prolonged economic downturn could lead to a decrease in overall consumer demand, indirectly affecting the industrial real estate market.

Miami’s industrial sector could benefit from its strategic location as a gateway to Latin America and its robust port facilities. Despite a potential recession, the city’s role in international trade and logistics might sustain demand for industrial spaces. However, any significant disruption in global trade patterns or consumer demand could still negatively impact this sector.

Investment in commercial real estate might also see a downturn during a recession. Investors tend to be more risk-averse in uncertain economic times, leading to reduced capital flows into the CRE market. Property values may decline as a result of lower demand and higher vacancies, which could create opportunities for opportunistic investors but pose challenges for current property owners and developers.

In Miami, real estate investment trends could be influenced by the city’s attractiveness as a long-term investment destination. Its appeal to international investors and its diverse economic base might provide some stability. However, fluctuations in global investment flows and local economic conditions will play a crucial role in determining the extent to which Miami’s commercial real estate sector is impacted by a recession. The city’s proactive approach to development and its reputation as a vibrant urban center might help it weather economic storms better than some other markets, but it is not immune to broader economic forces.

Conclusion

The yield curve, particularly the spread between the 10-year and 2-year Treasury yields, has been a historically reliable indicator of economic recessions. Its current inversion raises valid concerns about future economic growth. However, while it remains a valuable tool for gauging investor sentiment and potential economic trends, it’s essential to consider a broader range of economic indicators and factors in making comprehensive economic forecasts. The current global economic landscape is complex, and while the yield curve suggests caution, it is not a definitive predictor of impending recession on its own.

Related Resources

To muddle it up some more, below is a set of posts that express varied opinions about the current state of the yield curve and what is may predict for the US economy:

• Investopedia: Inverted Yield Curve: Definition, What It Can Tell Investors, and Examples
• US News: Inverted Yield Curve; Is it Still a Recession Indicator?
• Fortune: Understanding the yield curve: Why economists use it to predict recessions
• Federal Reserve Bank of Chicago: Why Does the Yield-Curve Slope Predict Recessions?
• Goldman Sachs: Why this yield curve may not signal a U.S. recession
• Forbes: The Inverted Yield Curve Continues To Flash A Recession Warning
• Marketplace: An inverted yield curve usually signals recession. Is it wrong this time?
• CAIA: Far From Perfect: Inverted Yield Curves Don’t Reliably Predict Recessions or the Direction of the Markets
• AllianceBernstein: Why Today’s Inverted Yield Curve Isn’t Necessarily a Recession Warning

*Federal Reserve Bank of St. Louis, 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity [T10Y2Y], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/T10Y2Y, June 24, 2024.