The wail of the banshee is an omen of death in Irish folklore and just as frightening in economic terms in the US is the omen of the inverted yield curve.
The return of the inverted yield curve has led to fears that a recession is looming in the US. "CRAZY INVERTED YIELD CURVE", wailed US President Donald Trump in a tweet. He is, clearly, not a believer in this economic omen but it is something that has regularly come before an economic dip in the United States.
..Spread is way too much as other countries say THANK YOU to clueless Jay Powell and the Federal Reserve. Germany, and many others, are playing the game! CRAZY INVERTED YIELD CURVE! We should easily be reaping big Rewards & Gains, but the Fed is holding us back. We will Win!— Donald J. Trump (@realDonaldTrump) August 14, 2019
So what is an inverted yield curve? Many people have asked that very question in recent weeks. In fact, there was a spike in searches for the term on Google, particularly after President Trump's tweet.
Google Trends shows that searches for "inverted yield curve" are on track for their highest month on record, and more than double the next highest month, which was December 2005. That was not too long before the last recession hit.
According to Conall MacCoille, Chief Economist with Davy, the inverted yield curve is when yield on 10-year government bonds falls below either 2-year yields or the Central Bank's policy rate.
"So for example, the 10-year US Treasury yield is currently 1.62%, 2-year 1.60% and Fed policy rate 2.0-2.25%. This is because markets expect the Fed will be forced into cutting its policy rate in the coming months or year – presumably because investors believe the US economy will slow sharply."
As a result, the yields essentially flip, and when you plot them on a graph, you get an inverted curve.
Mr MacCoille said there is good evidence inversion of the yield curve has preceded past US recessions "perhaps because investors saw the top of the cycle before the Fed was forced to react to slowing growth".
He said, however, that the same is not necessarily true for other countries. The yield curve inverted in the United Kingdom for several years during the mid-late 1990s but without a recession.
"It's also argued the long-term yields are depressed this time around by quantitative easing, and by the aging of the population leading to a savings glut," Mr MacCoille added. "So arguably the signal from long-term interest rates on future growth prospects is distorted."