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Yield Curve Shows 60% Chance of Recession, Deutsche Bank Says

The Wall Street Journal The Wall Street Journal
By Ben Eisen

The so-called yield curve suggests there’s a 60% chance of a U.S. recession occurring in the next 12 months, according to analysts at Deutsche Bank, led by Dominic Konstam. The calculations attach the highest probability to an economic contraction since the financial crisis.

The yield curve, typically measured using the level of long-term rates relative to short-term rates, has gained particular attention this year because of the narrowing difference between the two, often thought to signal an economic slowdown. Some measures are at their flattest since 2007.

The bank’s fixed-income researchers looked at the difference between the three-month and 10-year U.S. Treasury yields, which has been narrowing sharply in recent months. Adjusting for the low level of short-term rates suggests that the yield curve is already inverted, they found.

“Given the historical tendency of a very flat or inverted yield curve to precede a US recession, the odds of the next economic downturn are rising,” the analysts found.

ENLARGE

Other banks have used similar analyses to a get a read on the yield curve’s recent moves. Bank of America Corp.’s Merrill Lynch found in early February that the difference between the three-month Treasury yield and five-year note yield may already be inverted, when adjusting for the fact that short-term rates are so close to zero. That signaled a higher probability of a recession than the bank’s economists were predicting.

The value of the yield curve as a recession indicator may not be what it once was, with many questioning whether the low level of short-term rates has diminished its signaling mechanism altogether. With heavy foreign demand for long-term Treasurys and short-term rates that are held down by easy-money policies, there are increasing questions about whether the factors compressing the yield curve are really tied to a slowing economy.

Still, with the 10-year Treasury note yield touching a new record low Tuesday morning, the factors that are pressuring the yield curve show little sign of relenting.