Yield Curve Tells the Fed to Hold on Rates

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Imagine if you could predict recessions, years in advance, more accurately than professional economic forecasters, just by looking at a few data points. Well, according to a 2008 paper by economists Glenn Rudebusch and John Williams, you can.

The data you have to look at is what’s known as the yield curve — a technical term for the different interest rates on government bonds of various maturities. Here’s what those interest rates look like right now:

You’ll notice that the curve slopes upward to the right, meaning that longer-maturity bonds pay higher interest rates than shorter-maturity bonds. That’s typical. The most likely reason is that short-maturity bonds are more liquid — it’s easier to get your money out quickly without being exposed to the risk of a market downturn.

But sometimes, this relationship changes. When short-term rates are higher than long-term rates, the yield curve is said to have inverted. A recession tends to follow in the next couple of years. 

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