This Yield Curve Inversion Is “Different”, Says Goldman Sachs

(Bloomberg) — While the deeply inverted yield curve has stoked investor concern about the prospect of a recession, Goldman Sachs Group Inc. has a different message: stop caring.

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“We do not share the widespread concern over the inverted yield curve,” Jan Hatzius, the bank’s chief economist, wrote in a note on Monday, reducing his assessment of the likelihood of a recession by 25% to 20%, after a lower than – inflation report due last week.

Hatzius takes issue with most investors who point out that curve inversion has a near-flawless record of predicting economic downturns. Three-month Treasuries have produced more 10-year notes before each of the last seven US recessions. Currently, short-term yields are more than 150 basis points above longer-dated bonds, near the biggest reversal in four decades.

Read more: Goldman’s Hatzius cuts U.S. recession risk next year to 20%

Normally, the curve is sloping upwards because investors demand higher compensation – or term premium – for holding longer-dated bonds than short-dated bonds. When the curve inverts, it means investors are anticipating rate cuts big enough to overwhelm the term premium, such a phenomenon only occurs when the risk of recession becomes “clearly visible,” Hatzius explained.

This time, however, things are different, the economist said. This is because the term premium is “well below” its long-term average, so it takes fewer expected rate cuts to invert the curve. Also, as inflation cools, it opens “a plausible path” for the Federal Reserve to ease interest rates without triggering a recession, according to Hatzius.

When economic forecasts turned too pessimistic, Hatzius added, they put more than warranted downward pressure on long-term rates.

“Thus, the argument that the inverted curve validates the consensus forecast of a recession is circular, to say the least,” he wrote.

–With the help of Liz Capo McCormick.

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