Money Rehab with Nicole Lapin - The Recession Warning Bell Is Ringing

Episode Date: July 7, 2023

The classic definition of recession is reactive, not proactive— which makes the definition totally useless for anyone looking to protect their money. But, there is a proven warning sign of a recession. Nicole explains how to read the signs, and what it means for our financial future.

Money rehabbers, you get it. When you're trying to have it all, you end up doing a lot of juggling. You have to balance your work, your friends, and everything in between. So when it comes to your finances, the last thing you need is more juggling. That's where Bank of America steps in. With Bank of America, you can manage your banking, borrowing, and even investing all in one place. Their digital tools bring everything together under one roof, giving you a clear view of your finances whenever you need it. Plus, with Bank of America's wealth of expert guidance available at any time, you can feel confident that your

money is working as hard as you do. So why overcomplicate your money? Keep it simple with Bank of America, your one-stop shop for everything you need today and the goals you're working toward tomorrow. To get started, visit bofa.com slash newprosmedia. That's b-o-f-a dot com slash n-e-w pros p-r-o-s media. bfa.com slash newprosmedia. I'm Nicole Lappin, the only financial expert you don't need a dictionary to understand. It's time for some money rehab. it's time for some money rehab. All right, money rehabbers, let's talk about macroeconomics. Who's excited? Today, we're going to be talking all about the inverted yield curve. And I know that sounds like a whole mess of jargon, and it kind of is, but I promise I wouldn't throw jargon at you if it wasn't super important. And this is super important because so many pros argue that an inverted yield curve is one of the

best and only signs of an impending recession. This is valuable because the way we diagnose recessions is reactive, not proactive. For example, the classic definition is that a recession is any period where the inflation-adjusted gross domestic product, or GDP, declines for two quarters. And since you don't get GDP numbers until after those two quarters, it can be more than six months until you know you're in a recession, so not that helpful. Economists use a more complex definition describing a recession as a period of economic contraction. The GDP shrinks, but so do incomes, retail sales, and manufacturing. The only thing that grows, unfortunately, is unemployment. While you can make that judgment call a little quicker than waiting two quarters for the official GDP numbers, it's still not

instant. So the takeaway from all of this is that there isn't some red warning light that flashes on the desks of economists everywhere to alert them when a recession starts. Rather, it's something that happens somewhat gradually and can sort of sneak up on you. But there is a warning signal, and that warning signal has been flashing for a while now. That signal is called the inverted yield curve. Yes, back to the jargony mess, but I promise you will thank me. I think it's time that we break this down once and for all.

When I say inverted yield curve, you're probably thinking to yourself, OK, curve, I can picture that. Inverted, that makes me think of something going upside down. Yeah, if you can picture that, you're on the right track. When we talk about an inverse curve, we mean that whatever we're measuring is sloping downward or decreasing instead of curving upward or growing. In the case of inverted yield curves, we're measuring the difference between long and short-term treasury yields. So let's step back for any money rehabbers or anyone who needs a refresher.

The government sells treasuries, bonds, notes, and bills. Treasuries are different types of debt with different names depending on how long they last. The very longest are bonds, which take 20 or 30 years to mature. The treasury notes, which take 2, 3, 5, 7, or 10 years to mature, and finally, treasury bills, which mature in less than a year and are available for as little as four weeks. It gets confusing because sometimes people will refer to all of these as bonds, even though only the two longest are officially known as bonds. For this episode, I'll be using treasuries to refer to all of these different kinds of

offerings because that's actually the correct language. So treasuries allow investors to lend the government money. In return for the use of your money, the government pays you interest. Generally, the longer the length of time you lend the money, the more interest you'll make. Since you don't have access to that money for that time, it makes sense that you get more compensation. You're also taking on more risk because you're missing out on other potential money-making opportunities, right? You could invest in a lot of other things for the next 10 or 30 years. If you think the future is going to be amazing, that in 10 years the stock market is going to be

booming, inflation will be low and your paycheck will be fatter then the government needs to pay you a higher interest rate to get you to buy longer dated treasuries otherwise you would just buy stocks but what if you weren't that optimistic sometimes people can have such a dim view of the future that longer dated treasuries have a lower yield than shorter dated treasuries. This whole mix results in the yield curve inversion. And when that happens, watch out because historically it has been followed by a recession. An economist named Campbell Harvey, a professor at Duke University, first noticed this relationship. It's important to note here that his research

focuses on a specific yield curve, the special relationship between two types of treasury yields, the 10-year yield and the three-month yield. The difference between the 10-year yield and the three-month yield is 8 for 8 in predicting recessions since 1968. And by the way, this isn't about them inverting for a day or two. This is about a sustained inversion because sometimes short-term treasuries can seem risky for other reasons. You don't have to look hard for an example of this recently. During the debt ceiling standoff, where there was a fear that the government wouldn't honor its debts, short-term treasuries were paying more than long-term treasuries, which makes sense. Everyone knew the problem would be resolved at some point, but it wasn't clear when, so suddenly short-term treasuries were seen as risky.

But that was a temporary glitch. For the yield curve inversion between the 10-year and the 3-month yield to be meaningful as a recession signal, it needs to be a sustained inversion. In other words, it needs to last for at least a quarter. That is the situation we find ourselves in now, and then some. The yield curve has been inverted since October of 2022. But we aren't technically in a recession. So what gives? That's the question, and no one quite knows the answer to it. One possibility is that the yield curve is a warning signal and not the starting bell. Like the recession is out there, but it hasn't hit us yet. But Campbell Harvey, the guy who discovered the yield curve inversion situation, for a while he's had a different theory. He thought that there was a possibility that maybe,

just maybe, this time, the ninth time, would be a false alarm. Okay, and why did he think that? He had a couple of reasons. Right now, the labor market is stronger than it's been during other inversions. Dr. Harvey also believes that debt is less risky than it has been. But he also believed that the widespread popularity of the yield curve inversion as a recession indicator has altered its impact. If everyone knows the inversion of the 10-year and the three-month yields result in a recession, then businesses can change their investment strategies before the recession strikes and ultimately prevent one. But Dr. Harvey has been warning for months that the Fed needs to stop raising rates, which they have not done. In his more recent appearances, he said that he is no longer optimistic about the future and he no longer thinks this inverted yield curve is a false

alarm. He thinks there's a real chance that the Fed has overshot the mark and is going to push us into a recession. Currently, they have paused raising interest rates, but what the future holds is still a little bit TBD. The Fed says they'll probably raise rates again two more times this year. And Dr. Harvey thinks that is two times too many. And again, it's worth noting that right now we aren't in a recession and we don't know for sure if we will be. Even if we do head into a recession, it won't be something we immediately realize has happened. But if right now you're doing okay, this is the time to make sure your safety net is in order. Do you have that emergency savings account? Do you have a handle on your debt? I don't know if or when a recession is coming, but chances are that at some point in your lifetime,

something bad will happen. It could be a recession or it could be another black swan event that catches you off guard. The same safety net will protect you from both. For today's tip, you can take straight to the bank. While you're battening down the financial hatches, remember that your PayPal account isn't a safe place to store cash. PayPal, Venmo, any of those apps are not FDIC insured. In the event of a recession or other economic uncertainty, it's best to have your money in a safe place and stashing it in your PayPal account is not that. So if you have any money parked in a payment app, just move it over to an FDIC insured bank account instead.

Money Rehab is a production of Money News Network. I'm your host, Nicole Lappin. Money Rehab's executive producer is Morgan Levoy. Our researcher is Emily Holmes. Do you need some money rehab? And let's be honest, we all do. So email us your money questions, moneyrehab at moneynewsnetwork.com to potentially have your questions answered on the show or even have a one-on-one intervention with me. And follow us on Instagram at moneynews and TikTok at moneynewsnetwork for exclusive video content.

And lastly, thank you. No, seriously, thank you. Thank you for listening and for investing in yourself, which is the most important investment you can make.