Can Yield Curve Disinversions Accurately Predict Future Recessions?

January 27, 2025

When examining the potential of yield curve disinversions to predict future economic recessions, it is vital to understand the historical relationship between interest rates across different maturities. An inverted yield curve occurs when short-term interest rates surpass long-term rates, a scenario often seen as a precursor to recession. The conversation around disinversions, where the yield curve returns to a positive spread after being inverted, poses an intriguing question—can these disinversions provide accurate recession forecasts?

Historical data spanning from 1960 reveals that several recessions were anticipated by analyzing yield curve patterns, particularly focusing on the 10-year and 3-month Treasury term spread. The concept of a “disinversion dummy” is employed to mark the first month a disinverted curve appears, returning to a positive spread post-inversion. Researchers have found that adopting a four-month lead offers an optimal approach to predicting recessions, with a pseudo-R2 value of 0.023. These findings suggest that while disinversions can highlight potential economic downturns, the reliability of this predictive measure remains questionable.

Notably, the model in discussion failed to predict the 1960-61 and 1990-91 recessions accurately. Despite these misfires, the data suggests a recession forecasted for April 2025. This leads to critical scrutiny on the dependability of using disinversions for economic forecasting, especially when the initial curve inversion does not successfully predict an impending recession. The predictive capacity of yield curve disinversions carries both promise and uncertainty. Analysts emphasize the importance of considering the strengths and limitations inherent in this approach. While yield curve behaviors provide valuable economic insights, it is clear that relying solely on disinversions as a definitive indicator for recessions may not always yield precise outcomes.

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