Economists worry about warning sign suggesting future recession
AUSTIN (KXAN) – As many consumers anxiously watch rising gasoline prices and soaring inflation, economists are sounding the alarm over a different warning sign that could indicate a future recession.
The yield curve follows the difference between the cost of borrowing in the short and long term.
When that curve inverts, meaning it’s cheaper to borrow money long-term than short-term, economists say it’s a sign that a recession could be imminent.
On Friday, the difference between the two was just 0.25%, the closest since March 2020, before jumping this week.
Texas State Associate Professor of Economics Andrew Ojede spoke to KXAN about what this could mean for the economy.
This conversation has been lightly edited for brevity.
To M Miller: Can you explain what the yield curve is and what happened to it?
Andrew Ojede: The yield curve is essentially a plot of interest rate combinations, versus the time remaining to maturity. So what happened in the market, people were expecting the Fed to start raising rates due to higher inflation expectations. Typically, what happens when the Fed starts raising rates is that interest rates on short-term bonds rise disproportionately more than long-term rates. This leads to the flattening of the yield curve, and if this trend continues, the yield curve would invert, meaning that short-term bond rates could rise more than long-term bond rates. This is a clear sign that a recession is in sight.
To M: If you have an inverted yield curve, what does history tell us about what will happen next?
Andrew: When you have an inverted yield curve, it basically means that interest rates are rising faster than anything else, so the cost of borrowing for many businesses will increase. Companies will start laying off workers and this could potentially lead to a severe recession.
To M: What other economic indicators point to this possible recession?
Andrew: Going back to the pandemic, the government pumped out a lot of money, COVID bailout (money), but this happened during the lockdown when no one was spending those dollars. Late last year, the fourth quarter of 2021, Americans did everything they could to start spending that COVID money. The demand for goods and services has therefore increased rapidly, which has pushed inflation expectations to a very high level.
To M: How convinced are you that we are headed for a recession? Is this still a fairly open question?
Andrew: This is still a fairly open question. It also depends on what happens in Russia and Ukraine, because don’t forget that we are very interdependent. Globalization means that the United States does not act alone. We are linked to the rest of the global economy. Generally, when there is a crisis in an area, a region of the world, it can have an impact on businesses here at home. So there is a very high probability that if this conflict in Ukraine continues, the United States could face an economic crisis here.