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Over the course of the last 12 months,
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we've seen the United States yield curve
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steepen. This is when the yield curve
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comes out from what's called an
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inversion when it is below 0%. And as
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we've covered many times before on this
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channel, this is a notorious
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recessionary signal. The yield curve
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steepened in late 2007, right before the
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beginning of the great financial crisis
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in early 2001, right before the dotcom
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bust. And we have many, many more
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examples of yield curve steepenings that
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were subsequently followed by US
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economic recessions. And this, by the
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way, includes the steepening that
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occurred just a few months before the
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onset of the Great Depression in the
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1930s. The only problem is in the vast
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majority of these examples, a recession
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began within 12 months of the yield
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curve steepening. And yet today, the
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yield curve steepening began in mid 2024
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has not, as of the making of this video,
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been followed by a recession. Real GDP
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growth in the United States remains at a
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very solid 2% per year, and the
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unemployment rate is currently sitting
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at 4.2%. 2% which is within the range of
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what the Federal Reserve considers to be
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full employment. And just in case you
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don't trust the US government's numbers,
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just look at the stock market. It's
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sitting just a few percentage points
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below its all-time high. Not exactly
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something you would expect to see if we
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were actually experiencing a recession.
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Now, some of you might be thinking to
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yourselves that perhaps we're just
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around the corner of seeing all of these
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data points begin to turn in the
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opposite direction. that GDP growth is
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about to decline severely, unemployment
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rate is about to rise, and the stock
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market is about to fall. But the rest of
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you are thinking that perhaps it's
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finally time to conclude that the yield
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curve has failed as a recession signal
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this time around. We'll try and provide
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a clear answer to that in this video.
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And in order to do that, we first need
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to look at why the yield curve works so
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well as a predictor of economic
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downturns. When the yield curve is
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inverted, it means that short-term
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interest rates are above long-term
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interest rates. This is something that
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is primarily influenced by the Federal
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Reserve that can adjust short-term
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interest rates as they wish. What's also
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known as the Federal Funds rate. And
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when they raise interest rates enough to
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invert the yield curve, it sets off a
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chain reaction that eventually causes a
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recession to occur. Most of this chain
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reaction simply comes from the fact that
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credit conditions are tighter when the
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yield curve is inverted, which means
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that banks limit lending to people and
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businesses, which slows the economy down
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and eventually can cause a downturn. As
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we'll take a look at in a second, this
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chain reaction typically takes about 12
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months to take place. The very opposite
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is true when the yield curve is steep,
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or in other words, at elevated levels.
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This is when short-term interest rates
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are much below long-term interest rates,
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which provides an environment that is
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good for growth. Credit conditions are
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loose, which means banks are lending
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money quite easily, which provides the
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right conditions for the economy to grow
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looking forward. So that's how the yield
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curve works in theory. But what does it
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look like in practice? Take this line
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here that shows us whether the US
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economy is growing or contracting at any
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given point. When this line is above
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zero, the US economy is growing. When
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it's below zero, the economy is
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contracting. and is in a recession. As
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you can see, we're currently sitting at
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about a 2% economic growth today. Now,
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let's add the yield curve on top. But
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here, we've actually made it so that the
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yield curve has been shifted forward by
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12 months relative to the line showing
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us economic growth. And when we do this,
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we can see that the two lines match each
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other almost perfectly. Let's do a quick
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sketch to make sure that we're being
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very clear regarding how this works.
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when the yield curve goes up or down
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that is followed 12 months later by a
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corresponding move up or down in the
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economy. And so when we shift forward
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the yield curve the two lines match each
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other very very closely. But most
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importantly the yield curve helps us
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predict what the economy is going to do
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over the next 12 months. You can quickly
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understand here why the yield curve is
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considered to be such a powerful
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macroeconomic indicator. There is just
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nothing else like it. But like any
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indicator, it isn't perfect. Just
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looking at this chart, we can quickly
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notice that there are some moments where
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a yield curve inversion did not lead to
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a contraction in economic growth. But in
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the vast majority of cases, when the
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yield curve inverted, within the next 12
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months, you saw a recession materialize.
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Today, we have had an inverted yield
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curve since late 2022. And despite this,
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the economy has held up so far very
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well. But as you can see, we are still
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in the danger zone right now. Exactly 12
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months ago, the yield curve was still
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inverted, which could mean that the
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economy continues to be vulnerable to
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slowing down over the next few months.
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It wasn't until October of 2024 where
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the yield curve began to steepen and
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come out of its inversion. So that means
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that until October of 2025, we are still
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in the zone where the yield curve signal
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could still come to fruition and
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accurately forecast an economic
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downturn. So that's roughly another five
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months before we'll know absolutely for
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sure whether this yield curve signal
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that we've had has completely failed or
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not to predict a recession. So this
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naturally brings in the question of
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whether we should expect a recession to
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occur within the next 5 months. And in
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order to answer that question, we have
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to understand why the economy has so far
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been able to avoid a recession despite
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the yield curve having been inverted.
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The first reason is that the US has had
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a very tight job market. job openings in
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late 2022, which was the moment when the
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yield curve initially inverted, were at
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much higher levels than anything we had
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previously seen over the last 20 years.
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So, you had massive levels of hiring
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happening at the time, which is a very
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different look to what the number of job
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openings looked like right before the
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2008 recession or right before the 2001
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recession. In both of these cases, the
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job market was a lot weaker and the
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yield curve inversion simply pushed the
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economy over the edge and into a
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recession. Now, since 2022, we've seen
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the job market weaken considerably. The
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number of job openings has dropped by
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30% since. So, we're definitely no
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longer in the same situation today. And
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arguably, looking at this data, the
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economy is more vulnerable to dipping
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into a recession today than it was a
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couple of years ago. Overall, however,
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the job market is still in a better
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shape than it was preandemic. So, we're
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not in a catastrophic situation either.
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The second reason the economy has been
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able to avoid a recession, is that
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corporate profit margins have been
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extremely high in the US. In fact,
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they've been at the highest levels in
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recorded history, which isn't what you
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typically see before a recession
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happens. What typically happens heading
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into a downturn is that for reasons X,
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Y, or Z, businesses see their profit
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margins contracting, and as corporations
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see that happening, they naturally seek
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to cut costs, which in other words means
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laying employees off. And that is one of
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the defining characteristics of a
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recession. When you look at corporate
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profit margins throughout history and
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highlight all of the recessions that
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have occurred, we do see that in the
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vast majority of cases, you have
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corporate profit margins that decline
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before the recession starts. Now, the
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actual reason for why corporate profit
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margins decline varies case by case. In
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the 1970s, oil shocks and rising
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interest rates very much contributed to
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declining corporate profits. In 1999,
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the tech bubble bursting was likely the
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key catalyst that brought corporate
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profit margins down. In 2006, the
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combination of the housing bubble
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bursting and oil prices rising
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aggressively were likely responsible for
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the decline in profit margins that
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preceded the Great Recession. Today, we
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haven't seen corporate profit margins
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declining. However, now we could say
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that profits peaked in late 2023, but
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overall they've remained quite elevated
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since. Now, we've argued that Donald
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Trump's tariffs could potentially drag
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down profit margins, which could
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eventually bring about a recession. But
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for now, corporate profits remain
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sky-high, which could, in our opinion,
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provide some more dry powder for the
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economy to avoid a recession over the
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next 5 months, as businesses really
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don't need to be cutting costs right
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now. Now, I want to be clear, we could
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be completely wrong about this, and this
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is what trading is all about. It's about
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weighing the odds of certain things
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happening and placing bets on them all
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while managing our risk in the event
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that we're wrong about these things
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happening. Right now, we have positioned
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ourselves to take advantage of a
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resumption of the bull market on stocks
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heading into the end of 2025 as we do
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expect the economy to hold up. It's
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entirely possible that we need to adapt
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this position if the data changes. If
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you want to follow all of our decisions,
00:08:24
our entire strategy in real time, make
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sure you're subscribed to our membership
00:08:28
at bravosresearch.com. We teach you how
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00:08:34
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