Here’s one way to get a straight story on the yield curve’s distortions lately: Go to the source.
More than three decades ago, Campbell Harvey discovered that when long-term Treasury yields fall below short-term yields, a recession typically follows. That relationship is preoccupying many investors right now after the market anomaly — known as a curve inversion — materialized toward the end of last year. The normally upward-sloping curve began developing kinks and, since then, various portions have flipped to negative and back, spurring debate about which is the most relevant indicator.
Harvey, a finance professor at Duke University’s Fuqua School of Business and senior adviser at Research Affiliates, is experiencing no such equivocation. His original analysis at the University of Chicago in 1986 identified the three-month to five-year spread as the relevant indicator on the curve. His work shows it needs to stay negative for a full quarter to reliably predict a recession.
Harvey says this metric predicted the slumps of 1991, 2000-2001 and 2008, and has given no false signals. And those who’ve relaxed, or even bounded into fresh trades since broader sections of the yield curve have begun to steepen, should take note: This one has been inverted since March 12.
“We’re 120 months of recovery since the last economic trough, and usually a cycle lasts — post World War II — 58 months,” Harvey told Bloomberg’s Mike Regan and Sarah Ponczek in the latest “ What Goes Up” podcast. “This is exactly the time when a trader or CEO or CFO really earns their keep, because a turning point is much more likely today than it was a few years ago.”