It’s Tempting To Ignore This Recession Signal, But Don’t

The dreaded yield curve inversion: it’s like the financial world's version of a black cat crossing your path, a signal that a recession’s up ahead. But while it provides a highly reliable heads-up that a recession is around the corner, it plays coy on when exactly the thing might hit.

The main reason for that is that the aggressive interest rate hikes that lead to a curve inversion tend to work with long and variable lags on the economy. And while they tend to unfold in a sequence Piper Sandler’s Michael Kantrowitz dubbed “HOPE” – impacting housing first, then orders, profits, and finally, employment – the exact time it takes to roll from one letter of this unfortunate acronym to the next varies. And with all the uniqueness brought by Covid-era disruptions and stimulus, predicting how the timing might play out this time is even trickier.

What we do know, however, is that the employment domino tends to be the last to fall. Typically, it drops after firms have started cutting back significantly, consumers have tightened their belts, and housing prices have dipped. And generally, markets have tended to slide right before the jobs sector starts to fall, underscoring the significance of anticipating a surge in unemployment.

There are reasons to believe that this may be about to happen. As you can see in this chart, unemployment typically begins its upward climb ten to 15 months after the curve inverts. A more pronounced spike usually follows – generally a few months to a year later, coinciding with the onset of a recession. And, sure, it may be different this time. But given we’re 11 months into this inversion, and other indicators (like a steepening of the curve) are flashing red, it’s worth paying attention now.