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November 10, 2017
Here are the 3 scary words that Wall Street is fixating on and why you should too

They are - INVERTED YIELD CURVE - and we haven't had such a condition since 2006, shortly before the Great Recession started in 2007. In fact, an inverted yield curve correctly predicted the last 7 recessions going back to the 1960's! It isn't a perfect forecaster; it had a false positive: an inversion in 1966. So, overall, it's is a pretty darn good indicator of a recession in about a year's time.
What is an inverted yield curve? When short term rates, typically measured by 2 year Treasury bonds and shorter expirations to maturity, actually rise above long term Treasury yields, as measured by the 10 year Treasury note.
There are a litany of things that could affect interest rates. But suffice it to say that right now, the yield on the 10 year Treasury note is only a little over 80 basis points (.8%) above the 2 year Treasury bond. That difference is called "the spread" between the 2 and 10 year. It's a narrow spread, to be sure.  
Currently, the yield on the 10 year note is slightly lower YTD. The 2 year yield is higher YTD. Generally, it is accepted that long term yields should be rising if the economy is improving, driving inflation higher. Unless investors think the economy is near the end of its current growth phase, that is. Regardless, if the 2 year and 10 year yields were the same, we'd have a flat yield curve. Those two interest rates being equal is rare and generally when they're close, the yield curve is called a "flat yield curve". Like I wrote above, the yield spread is narrow, but for now, the yield curve is very modestly upward sloping, indicating modest economic growth near term. 
Yield curve analysis, taken from the Federal Reserve Bank of Cleveland, is currently forecasting a low probability of a recession going out 1 year, as per the chart below:
The flatter the yield curve gets - the narrower the spread between the 2's and 10's - the lower the forecast is for GDP growth. When the spread is negative, the chance of an outright recession rises.
With all of the global central bank interference over the last 8 years, is yield curve analysis less useful? No one knows for sure, which is why it bears watching. But we do know that if banks are borrowing short term and lending at rates below those short term rates (because banks lend at long term rates), they'll lose money. Banks would hold back on lending, which would choke off the economy - just like the last 7 recessions. In other words, the "4" scariest words on Wall Street are "it's different this time". It's not. The bank lending math you just read never changes.
Here's another chart, Yield Curve Spread and Real GDP Growth, form the Cleveland FED. The shaded bars indicate recessions. When the yield curve goes down, the shaded bars come next. Yup, scary words indeed.

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