How to Flip a Yield Curve

If the recent yield curve panic proves anything, it proves that, in financial markets, what may start out as a mere statistical correlation, and possibly a spurious one, can become a genuine causal relationship. In particular, if enough people subscribe to a post-hoc fallacy, it may not stay a fallacy for long.A Self-Fulfilling ProphecyIt was, therefore, just a matter of time before the discovery that inverted yield curves often anticipate recessions resulted in the world ’s first yield-curve induced panic. And the distance between panic to recession is no great stretch. Knowing that the curve has turned turtle, and anticipating tumbling stock markets and shrinking incomes, the public rushes to trade stocks for more liquid assets, while bankstighten lending standards. Lo and behold, stocksdo tumble, and incomesdo shrink. A slowdown then threatens. Should the monetary and fiscal authorities fail to avert it, the slowdown can become a contraction. If the contraction lasts, it becomes a recession. And all thisbecause the yield curve went concave. Post hoc ergo propter hoc. Really.That an inverted yield curve now strikes the general public much as that acorn struck Chicken Little isn ’t itself the Fed’s fault. Although Fed officials and researchers have been among those who have drawn attention to the coincidence of past inversions and subsequent recessions, their writings on the topic have been anything but sensational. “Not all declines in the yield-curve slope are bad ...
Source: Cato-at-liberty - Category: American Health Authors: Source Type: blogs