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Quick Thought Of The Week: Inversion

Talk of a US recession lingers like a bad smell over global markets. Someone should open a window, turn on some fans and blow that foul odour out of the room.

Experts who have nothing better to talk about have latched onto the inversion of the US yield curve as evidence of a looming American recession. The yield curve hasn’t quite inverted yet….

…. But it has been getting close. So, it’s grist for the mill, especially when an inversion of the yield curve has been reasonably accurate in forecasting US recessions.

It’s true that long-term interest rates should be higher than short-term rates. After all, lending money over the long term can be riskier. So, that should mean higher interest rates.

But when the rates invert, long-term interest rates are lower than short-term rates. It could suggest that interest rates in the future could be cut because the economy might deteriorate. In other words, a possible recession!

But here’s the thing: recession could become a self-fulfilling prophecy, if we are not careful.

If consumers and businesses start believing the tea leaves, then households could cut back on spending and the companies start reining in investments.

Once they do, economic growth could slow, if not stall, and voilà – we could have the recession that the inversion of the rate curve had predicted.

In other words, we could easily talk ourselves into recession. That would be a shame because the global economy is ticking along quite nicely.

A version of this article first appeared in Stock Advisor.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore Director David Kuo doesn’t own shares in any companies mentioned.