Post Yield Curve Inversion Comparison Model (updated 07.08.24)

OVERVIEW

Will the United States economy be able to avoid recession, given that the 10-year and 3-month yield curve inverted last year? In other words, will this time really be any different? To answer these questions, we should compare the economic performance of this current economic cycle to previous economic slowdowns. 

The visualizations below, developed using RStudio's ggplot2 library as well as data sets from the US FRED website, focus on six economic indicators which are used by the National Bureau of Economic Research (NBER) to date economic cycles. An indicator for credit performance was also added because of its integral role in American economic activity. The first inversion of the 10y/3m yield curve was chosen as a logical baseline point to compare performance of each indicator, since every recession in the last fifty years was preceded by an inversion of the 10y/3m yield curve.

The visualizations are presented in pairs for each economic indicator -- the first graph depicts the raw, unaggregated data for each post-yield curve inversion period.  The second visualization, in contrast, aggregates all pre-recessionary data into one, neat line. Data for the 1966 economic cycle, which was the only "soft landing/" no-recession scenario which followed an inversion of the 10y/3m yield curve, was also added in order to provide a best-case analog for the U.S. economy.

US REAL INCOME (EXCLUDING GOV. TRANSFERS)

U.S. real income accelerated in November 2023, but is still running well within the pre-recessionary distribution, exhibiting moderately positive growth since the yield curve inversion though remaining considerably below real income growth during the 1966 economic cycle. Typically, real income reaches an inflection point within twelve months following a yield curve inversion, so Q1 and Q22024 will be critical for determining whether real income flips negative and thus exhibits recessionary trends.

The derivative of nonfarm payroll growth remains positive, residing near the middle of the distribution for this point in the cycle. The growth of nonfarm payrolls has been slowing in recent months, reflecting a rebalancing in labor market demand due to tighter monetary conditions. Like real income, nonfarm payrolls in past recessions typically flip negative between 12 and 18 months following the inversion of the yield curve, so the next two economic quarters will be critical to determining whether the job market remains in a healthy, non-recessionary state.

U.S. employment as measured by the household survey ticked down in December 2023. It is trending near the middle of the distribution, near a cluster of previous recessionary periods of time. Household employment is typically a more volatile measure of the labor market than nonfarm payrolls is, reflecting the data set's different set of assumptions. Regardless, household employment typically reaches an inflection point between 12 and 18 months after a yield curve inversion. 

Consumption, as measured by real PCE, is running near the top of the pre-recessionary distribution, likely reflecting significant household pandemic savings. On average, PCE typically remains positive throughout a recession, however, it can sometimes trend negative during recessions. As consumers face continued pressure from tightening credit conditions, persistent inflation, and a weakening labor market, the derivative PCE may weaken during 2024.

Retail sales is trending positive, near the middle of the distribution. On average, it does begin to trend negative near this point of cycle, so the next few months will be critical for determining if retail sales enters into recessionary territory.

Industrial production is running near the middle of the pre-recessionary distribution. Like other economic indicators previously explored, industrial production reaches a divergence point near this point in the economic cycle, so if industrial production flips negative within the near future, a recession may be imminent.

Credit creation in the United States is underperforming all previous pre-recessionary cycles, reflecting tighter monetary policies from the Fed and a series of regional bank failures during 2023.