Financial analysts have spent a lot of time this year discussing the yield curve. Specifically, they’ve pointed out that the yield curve is almost flat, and that an inverted yield curve almost always leads to a recession. They’re worried that the yield curve says a recession isn’t too far away.
In this article, a Federal Reserve economist tells how he interprets the yield curve. He’s not concerned about a recession occurring for at least several quarters and perhaps longer.
As we all know, however, correlation does not imply causality. This is a particularly important point to keep in mind when discussing the yield curve. As a set of market-determined interest rates, the yield curve not only reflects market participants’ views about the evolution of the economy but also their views about the FOMC’s likely reaction to that evolution and uncertainty around these and other relevant factors. In other words, the yield curve represents not one signal, but several. The big question is, can we pull these signals apart to help appropriately inform the calibration of policy?