There are questions as to whether it could be different this time. Did the Fed’s “experiment” in deliberately distorting the yield curve by pushing rates down to near zero affect the reliability of the yield curve’s message? Have inflows into the U.S. Treasury market from global central banks (where rates are especially low and/or negative), pension funds (taking advantage of strong equity markets and re-balancing portfolios to capture higher yields), and insurance companies—all helping to push down 10-year rates—also affected the accuracy of the yield curve in terms of projecting recessions?

The Federal Reserve Bank of Richmond, in a research paper published in December 2018, acknowledged that while yield curve inversions have preceded each of the past seven recessions, other circumstances can affect the shape of the curve besides concerns over the state of economic growth. The paper cites the minutes from the September 2018 FOMC meeting, which noted that an inverted yield curve could indicate rising chances for a recession, or central bank asset purchases that could “temper the reliability of the slope of the yield curve as an indicator of future economic activity.”

Former Federal Reserve Chair Janet Yellen weighed in on the inversion message, saying the inversion may be signaling the need for a rate cut at some point, rather than signaling a recession.

Other important indicators, including the health of credit markets where corporate bond spreads have tightened, and high yield credit spreads remain low, are important in how markets judge whether the inverted yield curve will be seen as a false signal. To be sure, each data release, indicating strength or weakness of the economy, will affect the yield curve, but for reliability, markets need to see persistence in the curve’s message, spanning weeks, not intermittent moves.

Market commentary is divided on the curve’s message, but if lower interest rates do spur auto sales and help the housing market, as recent mortgage applications indicate, the yield curve should begin steepening, indicating investor confidence in the economy. Similarly, if global growth begins to show signs of stabilization, it will also offer help in steepening the curve. All central banks, all markets, and all investors and traders are data dependent, but the yield curve, which is now being analyzed from every perspective, will remain hyper-alert for changes in economic direction. Don’t dismiss the inversion: Keep it in context with other key metrics, including PMI (Purchasing Managers Index), CDSs (credit default swaps) for high yield bonds, CRB Rind (raw industrials index), inflation expectations and unemployment claims.

Global Backdrop

As the economic slowdown unfolded in China and Europe, it seemed the U.S. would be immune to the forces causing a weaker economic landscape. And for the most part the U.S. has been resilient, but signs of U.S. domestic weakness have forced the Fed to engineer a prolonged “pause” in its monetary trajectory. Concerns are rising that the Fed was too late, and that 2018 rate hikes continue to work their way into the real economy, stifling growth. In addition, ongoing trade negotiations with China have, to some degree, slowed corporate capital expenditures as firms wait for clarity. Exports have slowed as economies in China and Europe have slowed, although U.S. exports are beginning to show signs of improvement, which should help bolster first-quarter GDP results.

The ECB has responded to slower growth in the eurozone by commenting on downside risks and curtailing its guidance for rate normalization beginning in September. In addition, the ECB has signaled its willingness to support increased “targeted longer-term refinancing operations” (TLTROs), designed to have banks lending directly into the real economy, particularly companies. ECB President Mario Draghi and ECB Chief Economist Peter Praet have suggested that if the eurozone economy deteriorates further, there remains a full range of measures that can be employed. While not discussed publicly, the ECB could resort to private asset Quantitative Easing (QE) if the economy doesn’t gain traction. Draghi discussed the slowdown in fairly generic terms by stressing that if economic growth momentum weakens further it could lead to a more broad-based slowdown, especially if external demand remains weak, and if this spills over to domestic demand.

The Bank of Japan (BoJ) continues its zero-interest rate policy and QE, along with the purchase of ETFs as part of its stimulus package.

Given China’s important role within global trade, signs of economic stabilization should help foster optimism that demand will increase for imports and exports. The most recent data include industrial profits falling sharply in January and February. Consumer confidence slowed for the fourth time in five months. As a result, China continues to lower the reserve requirement ratio for banks and is directing funding into banks to be used for loans for companies. Most likely, if necessary, officials could cut lending rates in the near term. In addition, billions of dollars are planned for tax cuts designed to help the manufacturing, transport and construction sectors. Infrastructure spending is also being given a boost. In a recent speech, Premier Li Keqiang warned that the “environment facing China’s development this year is more complicated and more severe.” He stressed that the country must be prepared for risks and challenges that are either “predictable or unpredictable.” Negotiations continue for a viable resolution to the tariff dispute, with difficulties focused on reaching an agreement on the enforcement of technology transfer, cybersecurity and intellectual property.