I have read many articles where experts try to predict a recession based on their leading indicators. Some use the stock market, others use consumer confidence index, and the list goes on. I recently read an interesting article that plotted a measurement that seemed to predict every recession since 1976. While this may not be true for future recessions, a business owner should stay aware of a few indicators to be prepared. For recessions are opportunities for strong businesses to come out ahead of their competition.
What is the indicator?
It’s known as the “yield curve.” The yield curve is the interest rate of U.S. Treasuries at different maturity dates (6-month, 1 year, 3 years, etc.) that the U.S. government issues to finance some of its day-to-day operations.
During typical economic times, the short-term Treasury bond interest rate (“yield”) will be lower than the long-term Treasury bond yield. The reason is that the person investing in the long-term Treasury bond should get a larger yield (interest rate) for taking on the risk over a longer period, where inflation and other factors could impact the return on this investment.
How do you “Read the curve?”
When the yield curves align, referred to as “flat”, then their return is the same. For instance, a short-term and long-term Treasury bond both have a 5% interest rate yield.
It’s when the yield curve “inverts” which means the shorter-term Treasury bonds have a higher yield (i.e., interest rate) then the longer-term Treasury bonds, this becomes the red flag that a recession is coming. It’s the proverbial “canary in the coal mine” warning that the economy is about to turn down.
Ever since the Federal Reserve began publishing this information about short-term and long-term Treasury bond yields (that is, the ten-year two-year spread), it has accurately predicted a recession in the United States. It seems that none of the recessions in the last 70 years have occurred until the yield curve has inverted. Keep your eye on the ten-year, two-year interest rate yields; it might help you plan for the next downturn.
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