Aswath Damodaran: The Inverted Yield Curve: Is There A Signal In The Noise?

Here’s a short presentation by Aswath Damodaran on the recent inverted yield curve and whether there is a signal in the noise. He writes:

On December 4, 2018, the yield on a 5-year US treasury dropped below the yields on the 2-year and 3-year treasuries, causing a portion of the US treasury yield curve to invert.

Since inverted yield curves have predicted recessions almost perfectly for the last six decades in the US, it was viewed as a big reason for the market’s drop that day. In this session, I start with the impressive track record that inverted yield curves have had as recession predictors, posit that this may be because they are stand-ins for the “Fed” effect (on the economy) and then look at the data over the last 56 years.

I find that it is the short end (2 yr vs 1 yr), not the more common used long end (10 yr vs 2 yer), of the yield curve that offers predictive power, and even that power is limited. I also find that the post-2008 data yields very different results than the pre-2008 data, suggesting that the crisis may have reduced investor faith in the powers of the Fed and consequently altered any predictive power that the yield curve may have had prior to the crisis.

You can watch the short presentation here: