The European Central Bank said the yield curve may be less able to predict recessions because of the market distortions caused by massive central bank bond buying.
(Bloomberg) — The European Central Bank said the yield curve may be less able to predict recessions because of the market distortions caused by massive central bank bond buying.
The ECB, writing in its review of the July policy meeting, said central bank action has compressed the yield premium that investors demand to hold long-dated debt, which “could reduce the predictive content of the slope of the yield curve for economic growth.”
The comments tap into one of the hottest market debates in recent times, one that’s drawn views from the Federal Reserve and investors across Wall Street. Traditionally, an inverted yield curve, when short-term rates are higher than long-term ones, has been a clear sign of an impending recession.
But doubts are growing over whether it’s right this time, especially since the Treasury yield curve has been inverted for more than a year and many economists believe the US economy can keep expanding.
Read more: What an Inverted Yield Curve Means for Recession Odds
The ECB said in the statement, published on Thursday, that an inversion in euro-area yields “had reignited recession concerns among market participants.”
In Germany, the yield curve between the two and 10-year tenors is currently inverted by around 50 basis points. In July, it was about 80 points, the deepest inversion since 1992. While Europe’s largest economy exited a winter recession in the second quarter, growth is largely expected to be stagnant going forward.
Chair Jerome Powell said last year that it’s “hard to have some economic theory” on why an inversion between two- and 10-year Treasury yields should predict a recession, though he added that he does closely watch moves at the shorter end of the curve.
Others have also called the metric’s significance into question over recent months. Ed Yardeni, an economist who’s been covering the market since the 1970s, has proposed that the US curve inversion is signaling the slowdown in inflation that typically accompanies a recession, but not the actual recession itself.
(Updates with additional context throughout.)
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