At the end of August, international markets got into a state of panic, after one of the most closely watched variables started flashing, indicating an imminent correction: the yield curve.
We discussed about this and what it could entail for the economy with a sector expert, Davide Buccheri.
But before diving into the details, what is exactly the yield curve and why is it so important? “The yield curve measures the rates of interest that the US government has to pay for debt expiring at different maturities” Buccheri explains. “An inversion occurs when the 2-year interest rate rises to a higher level than the 10-year rate. This is an indication that investors expect some sort of short term turbulence and this expectation translates into higher risk premia for the corresponding maturities”.
Anyhow, according to Buccheri, this time we should not worry too much about the economy. “I’d say that this time the Fed has acted very rapidly, stomping on any possibility of a real inversion occurring. The September rate cut definitely put a stop to any chances of a prolonged inversion in the short term.”
“The curve did invert but it only lasted for a couple of days. Historically, inversions only led to recessions when the length of time of the inversion was substantially longer - something in the range of at least 30 weeks usually.”
Davide Buccheri then concludes with a word of caution: “We need to keep in mind that the only reason the inversion reverted was an intervention of the Fed in the economy. It remains to be seen whether this external force was enough to prevent a recession, or just silenced an alarm, without having any actual effects.