TheMReport

44 | TH E M R EP O RT SERVICING THE LATEST O R I G I NAT I O N S E R V I C I N G DATA G O V E R N M E N T S E C O N DA R Y M A R K E T A Harbinger of Recession? Experts believe that the much-dreaded inverted yield curve could spell out a broad economic downturn if it persists. Q uestions around the possibility of a cyclical recession have been looming large over many economic sec - tors in recent months, includ- ing the U.S. mortgage market. In March 2019, that possibility loomed even larger as the three- month and the 10-year Treasury yields inverted for the first time since mid-2007. The Significance of a Yield Curve Inversion W ith the inversion coming on the heels of the Federal Reserve's announcement that it was not planning further interest rate hikes this year, combined with other concerns that an economic slowdown may be on the horizon, the inverted yield curve sent stocks plummeting. Diane Swonk, Chief Economist at Grant Thornton, told PBS News Hour that the inversion was "the straw that broke the camel's back" for many investors. "Historically, an inverted yield curve is a significant sign that points to the development of an economic slowdown in the near to medium term," said Five Star Global President and CEO Ed Delgado. "This latest development is another in a series of economic markers that support the possibil- ity of a future recessionary cycle." Ted Bauman, Senior Research Analyst and Economist at Banyan Hill Publishing, told MReport, "For forecasters, inverting yield curves have about the same significance as voodoo-cursed totems for followers of that religion. That's because they have preceded the last seven official U.S. recessions. They are, therefore, not to be taken lightly." Speaking of how the inverted yield curve will bring talk of a recession to the forefront, Tendayi Kapfidze, Chief Economist at LendingTree, said, "What's often not discussed is the mechanism by which an inverted yield curve can lead to a contraction in the economy. By having longer-term debt return less than short-term debt, an inverted yield curve makes lending less profitable for banks as they borrow short-term and lend long-term. As lending becomes less profitable, banks tighten their standards and extend less credit. This leads to less lever - age in the economy, which results in less spending and investment thus less growth." Kapfidze pointed out that "the banks (and other lenders) are the transmission mechanism for the inverted yield curve to the broad - er economy, and that's why the bank stocks were the first to react to the inverted yield curve. Thus, the yield curve is a recession indicator, though it does so with a significant lag of 18-24 months and needs to stay inverted for some time, say at least a quarter, to give a high confidence signal." Speaking of the Fed, Bauman said, "In the current scenario, bond markets are also acutely aware of the fact that the Federal Reserve has 'chickened out' of its intention to liquidate its holdings of securities left over from the 2008-2009 financial crisis. By buy - ing up long-term T-bills to push down interest rates, and absorb- ing near worthless collateralized debt obligations (CDOs), the Fed effectively 'loaned' financial markets $2.5 trillion during that period." Bauman indicated that the enormous amount of liquid - ity has been the prime driver of the rise in U.S. stock valuations, which have reached unsustainable levels, since that time. The yield curve assumes great significance, Bauman noted "because it is based on demand and supply in the one market that most closely approximates the textbook model of demand and supply—long-term treasury bills. Whereas short-term interest rates are set by the Federal Reserve, rates (yields) for the 10 year T-bill are set in the bond market. Bond traders are able to incorporate information almost instantly and use that to adjust their bids." According to Bauman, it is this interaction between the future demand for money and the excess supply of available money left over from the period of "quanti - tative easing" that is behind the inverted yield curve today.

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