Over the last 12 months, we’ve seen the United States yield curve steepen.
This happens when the yield curve comes out of an inversion (below 0%).
As we’ve covered many times, this is a notorious recessionary signal.
The yield curve steepened in late 2007, right before the Financial Crisis.
In early 2001, right before the Dot Com bust.
In fact, there are many examples of yield curve steepenings followed by recessions.
This includes the steepening that occurred just months before the onset of the Great Depression in the 1930s.
In majority of the cases, a recession began within 12 months of the yield curve steepening.
Yet today, the yield curve steepening that began in mid-2024 has not been followed by a recession.
Real GDP growth remains at a solid 2% per year.
The unemployment sits at 4.2% – within the Federal Reserve’s full employment range.
And if you don’t trust government data, just look at the stock market.
It’s sitting just percentage points below its all-time high.
Not exactly what you’d expect during a recession.
Some of you probably think we’re about to see these numbers flip and a downturn begin.
Others believe this might be proof that the yield curve signal simply failed this time.
In this article, we’ll try and provide a clear answer.
To do that, we need to first look at why the yield curve works so well as a recession predictor.
Why The Yield Curve Works
When the yield curve is inverted, short-term interest rates are above long-term rates.
Now the Fed directly controls short-term rates.
When they raise rates enough to invert the curve, it sets off a chain reaction that eventually causes recession.
Most of this reaction comes from tighter credit conditions when the curve is inverted.
Banks limit lending to people and businesses, slowing the economy and often causing a downturn.
This chain reaction typically takes about 12 months.
The opposite is true when the yield curve is steep.
This is when short-term rates are much below long-term rates.
Credit conditions are loose, banks lend easily, creating conditions for economic expansion.
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The 12-Month Pattern
When we shift the yield curve forward by 12 months relative to economic growth data, the 2 lines match almost perfectly.
When the yield curve goes up or down, that’s followed 12 months later by corresponding economic moves.
This is why the yield curve is considered such a powerful macroeconomic indicator.
But like any indicator, it is not perfect.
There are moments where inversions didn’t lead to economic contractions.
However, in the vast majority of cases, when the curve inverted, within 12 months you saw recession materialize.
Today, we’ve had an inverted yield curve since late 2022.
Despite this, the economy has held up remarkably well.
But we’re still in the danger zone.
Exactly 12 months ago, the yield curve was still inverted.
It wasn’t until October 2024 that the curve began steepening again.
This means until October 2025, so roughly another 5 months, we’re still in the zone where the yield curve’s recessionary signal could come to fruition.
This naturally leads to the big question:
Should we expect a downturn within the next 5 months?
To answer that, we need to understand why the economy has defied the signal so far.
Why No Recession Yet?
First, the US labor market has been extremely tight.
Job openings in late 2022 (when the curve initially inverted) were at much higher levels than anything seen over the previous 20 years.
So, you had massive levels of hiring happening at the time.
This significantly differs from pre-2008 and pre-2001 recessions, where the job market was much weaker and the yield curve inversion simply pushed the economy over the edge.
Now, since 2022, the job market has weakened considerably.
Job openings have dropped 30%.
We’re no longer in the same situation, and arguably the economy is more vulnerable today than it was 3 years ago.
However, the job market remains in better shape than pre-pandemic levels.
So, we’re not at crisis levels either.
The 2nd reason the economy has stayed afloat is that corporate profit margins have been at the highest levels in recorded history.
This is not typical before recessions.
Usually heading into downturns, businesses see profit margins contracting.
As corporations witness this, they naturally cut expenses by laying off employees – a defining recession characteristic.
Throughout history, profit margins decline for various reasons before most recessions begin:
- 1970s: Oil shocks and rising rates
- 1999: Tech bubble bursting
- 2006: Housing bubble and oil price spike
Today, we haven’t seen profit margins declining.
They may have peaked in late 2023, but they’ve remained quite elevated since.
We’ve argued that Trump’s tariffs could potentially drag down margins.
But for now, corporate profits remain sky-high, providing dry powder for the economy to likely avoid a recession over the next 5 months.
Right now, we’ve positioned ourselves to take advantage of a resumption of the bull market heading into end-2025.
But if the data changes, we’ll adapt accordingly.
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