Key Bond Market Indicator Sparks Fear of Recession, But Economic Downturn Might Not Be Impending

Changes to a closely-watched bond market indicator that can signal recession has provoked concern among Wall Street analysts, but the inverted yield curve may not mean an economic downturn is impending.

The yield curve, which measures the yields rates on bonds with different maturity dates, has inverted prior to every recession in the last 40 years. Typically, short-term bonds provide investors lower yields because they present less risk.

But the yield rate on three-month bonds rose above the yield rate on 10-year U.S. Treasury bonds this week, trading with a gap larger than any since March 2007. Yields on the 10-year bond fell below 1.7 percent on Friday, and the 2-year bond had a yield as high as 1.64 percent.

While analysts are watching bond rates closely, and the inverted curve has provoked a flurry of ominous news articles, an inverted yield curve doesn't necessarily mean that a recession is looming.

"When we look at economic projections, we don't see a recession on the horizon," Sam Stovall, the Chief Investment Strategist at financial research firm CFRA, told Newsweek. In the last 40 years, "while we have had seven flat to inverted yield curves, all seven have led to rate cutting cycles. But only four led to recessions," he said, referring to 10-year and 2-year U.S. Treasury bonds.

The inverted yield curve accompanied other economic volatility ushered in by President Donald Trump's escalation America's trade war with China last week. U.S. stock markets plummeted after Trump announced his intention to levy additional tariffs against Beijing, with stocks registering their worst day and week of 2019. Weak business investment and a full percent decrease in GDP growth last quarter have provided other reasons to be worried about economic downturn.

But other signs indicate that the U.S. is not on the verge of entering a recession. U.S. GDP is expected to grow in the next two quarters, according to Action Economics. The company projects that U.S. GDP will grow 2.3 percent in the third quarter of the year and 2.5 percent in the fourth quarter, in spite of global trade volatility.

Consumer sentiment is also strong, in spite of global trade uncertainty. Last month's reading registered at 98.4, a 0.2 percent increase from the previous year and a 0.5 percent year-over-year increase. With consumer spending accounting for more than two-thirds of U.S. economic activity, flagging confidence levels can hit the economy hard.

Since 1960, recessions have also been preceded by double-digit year-over-year decreases in housing starts, the number of new privately owned housing units started. Despite decreasing 0.9 percent from May to June, housing starts are up 6.2 percent year-over-year, as of the latest reading.

"The financial market gyrations have been disproportionate to the tariff news but also to the reported data," Michael Englund, the chief economist for Action Economics, told Newsweek.

Yet even if markets over-reacting and economic downturn isn't imminent, a recession can't be permanently avoided.

Stock markets are a leading indicator, and Stovall told Newsweek that the market tends to anticipate recessions between six and nine months in advance. Metrics appearing to indicate economic health could quickly change.

Economists are clearly concerned about the potential impact of the U.S.-China trade war and its escalation increased predictions that global recession will come next two years.

A Reuters poll conducted this week found economists gave a median 45 percent probability of recession in the next 24 months, a 10 percentage point increase from July. Among economists who responded to an additional question, almost 70 percent said that the recent trade war escalation brought the next U.S. recession closer.

Even so, in spite of the trade war and significant shifts in U.S.-China trade, U.S. trade has proved resilient. As of May, U.S. imports and exports have both averaged 4 percent growth over the last two years, according to an Action Economics analysis. More recent predictions for annual growth projections showed both imports and exports for 2019 would come in far below the 4 percent level but rise again.

Traders work on the floor at the New York Stock Exchange on Wall Street in New York City on August 9. DON EMMERT/AFP/Getty Images