The yield curve has just steepened by a full percentage point, coming out of an inversion.
It’s a signal that’s preceded every recession in recent history:
- 2020: COVID-19 recession
- 2007: Great Financial Crisis
- 2001: Dot-com bust
But, the Recession Is Still a No Show
Despite the yield curve recession signal, the economy is holding up:
- GDP growth at a healthy 2%
- Job market remains strong
- Stock market at all-time highs
Is it time to bid farewell to the yield curve’s flawless track record?
Yield Curve 101: A Quick Refresher
First, let’s take a look at what the yield curve signal is.
The yield curve compares long-term bond yields (10-year) to short-term yields (2-year).
- Normal curve: 10-year yield > 2-year yield
- Inverted curve: 2-year yield > 10-year yield
When the Fed raises rates, it often cause san inversion – a sign of restrictive policy.
The steepening we’re seeing now typically happens when the Fed starts cutting rates due to economic weakness.
The Recession Hot Zone
When we look at where the yield curve is at the very beginning of the last 4 recessions, it’s actually different each time:
- 1989 & 2020: Recession started at 0.1% yield curve
- 2001: Recession at 0.5%
- 2007: Recession at 1%
So we can say there’s a “Hot Zone” when the yield curve is steepening and is between 0.1% and 1%.
Today, we’re in this “Hot Zone” – but that doesn’t mean the yield curve is invalid.
For example: In July 2007, the curve was exactly where it is today.
The recession didn’t hit until it steepened all the way to 1%.
If this repeats, the yield curve would continue steepening until Jan 2025 without a recession.
Now, if the yield curve steepens past 1% in the coming year without a recession, we’ll need to reassess its predictive power.
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The US Job Market
There’s another piece to this puzzle: initial jobless claims.
Initial claims mirrors the yield curve almost perfectly.
That’s been the case going back to the 60s
Why does this happen? Go ask the Fed. We’re just looking at the end result here.
But recently, jobless claims have remained strong despite the yield curve steepening.
This divergence presents 2 scenarios:
Scenario A: Jobless claims stay low, yield curve re-inverts
- Similar to brief periods in 1999 and 2006
- Could delay recession timeline
Scenario B: Jobless claims rise, catching up to the yield curve
- Mirrors 2007 pattern
- Could signal imminent recession
Government Spending: A Recession Buffer?
Some experts argue high government spending will prevent a recession.
But, government spending was also elevated before the 2008 crisis.
It didn’t prevent one of the worst economic downturns.
Our Outlook: Scenario B
At Bravos Research, we’re leaning towards Scenario B:
- We expect jobless claims to rise
- Aligning with the yield curve signal
- If we’re following a similar path to 2008, we can expect a start of the recession in about 3 months from now
What This Means for Stocks?
Typically, stocks fall in the months preceding a recession.
We saw this in 2000 and 2007.
But history shows stocks can rise until the very last moment before a downturn:
- July 1990
- February 1980
- September 1929
Given the conflicting signals, we’re maintaining a highly adaptable strategy.
Not because we want to be picking up nickels in front of the steamroller…
But, because we’re aware we could be wrong about the recession occurring in the next few months.
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- 17 ongoing Active Trades
- Average profit in 2024: 17.37%
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