Headlines are screaming that a recession is coming, but is it really?
The most common reason given by the media and those they quote is the so-called “inverted yield curve.” Commonly, when the Federal Reserve raises short term interest rates, it does so to slow a “hot economy” to protect against inflation. If it raises short term rates higher than current long-term rates, we are said to have an inverted yield curve. Yet, the inverted curve itself means nothing on its face.
Rather, consumers should take into consideration that the Federal Reserve raised short term rates up to about two percent in an effort to improve its ability to boost the economy in the next cycle. The Fed needed interest rates to be higher in order for it to drop rates when the economy slows. In other words, it did not adjust rates because of a hot economy or because it was concerned about high inflation.
At the same time, long-term rates are historically low (30-year bonds are paying two percent, for instance), which means it doesn’t take much for the short-term rates to be as high or higher than the long-term rate. Today, long term rates are low due to low inflation and competition from negative interest rates in the rest of the developed world. If you are holding large sums of money overseas, you can either pay to own a foreign bond OR buy dollars with which you can buy U.S. bonds and at least earn some positive interest. This massive purchase of dollars pushes up the exchange rate, and the massive purchase of bonds pushes their price up and yields down.
All this interest rate talk is one way of saying that one shouldn’t look toward inverted curves or bond prices to determine whether there is going to be a recession.
Instead of reading the headlines trying to know if we are in a recession – or if there will even be one – keep these things in mind:
- You cannot predict when a recession will occur.
- You cannot predict how the stock market will react in a recession.
- None of this talk of recession matters with a diversified portfolio invested in the long-term that is part of a broader financial plan.
My advice? Ignore the doomsday headlines, make sure you have a financial plan in place and live your life. Don’t have a financial plan? Or worried about the recession headlines? Contact a CFP® professional in your area today.