The dreaded yield curve inversion returned briefly in overnight trading. It's a classic trading signal that has preceded every recession in modern history.
Global stock markets recoiled overnight with the Dow Jones Industrial Average (DJIA) shedding 200 points. As coronavirus fears trigger a deeper selloff, a reliable recession indicator just flashed red.
During the overnight session, US Treasury bond yields briefly inverted. The 10-year yield dipped below the 3-month yield for the blink of an eye. Known as a ‘yield curve inversion’ this phenomenon has preceded every major recession.
As Bloomberg’s senior editor John Authers put it:
“Classic recession indicator.”
Dow Jones futures contracts slumped as much as 200 points overnight before settling around 0.5% lower.
This phenomenon isn’t just a niche trading signal. The Federal Reserve uses it to project the likelihood of recession. The Fed uses this yield curve as a “leading indictor” and tracks the spread monthly.
Based on this information, the Fed puts the probability of recession at 38% in July 2020.
This is the second time this week the yield curve has briefly inverted. And parts of the yield curve were inverted for several weeks through 2019.
The inverted yield curve is historically accurate at predicting a recession. But it has little to say about the timings. A recession is rarely imminent and may take months or a year to develop. The indicator has flashed a false signal once.
So will the Dow Jones fall into a deeper correction? More skeptical analysts would argue the yield curve must remain inverted for a prolonged period of time before we can confidently say a recession is imminent. Michael Lorizio of Manulife Asset Management said he’d need to see more evidence of a weak underlying economy.
“To really forecast any chance of near-term recession I think I’d need to see more fundamental support from economic indicators, not just relying on the yield curve.”
The rapid spread of China’s deadly coronavirus continues to dominate trading sentiment around the world. The outbreak has now killed 170 and infected almost 8,000, rattling global markets.
The World Health Organization (WHO) is now weighing the decision to declare an “international emergency.” Those two words could trigger a much deeper selloff as it would halt trade and tourism activity across the globe.
The WHO will meet today at 13.30 Geneva time to make a decision.
This article was edited by Samburaj Das.