When Perfect "There Can't Be A Recession" Indicators Fail

Tyler Durden's picture

Submitted by Pater Tenebrarum of Acting-Man blog,

A Dangerous Misconception

Ever since the echo bubble went into overdrive due to the Fed adding what by now are nearly $5 trillion to the broad US money supply TMS-2, while keeping the administered interest rate practically at zero, people have been looking for excuses as to why the latest bit of asset boom insanity will never end (few of them wanted to be long “risk” in 2009, but they sure are eager to justify their exposure now).

One popular theme gets reprinted in variations over and over again. Here is a recent example from Business Insider, which breathlessly informs us of the infallibility of the yield curve as a forecasting tool:  “This Market Measure Has A Perfect Track Record For Predicting US Recessionsthe headline informs us – and we dimly remember having seen variants of this article on the same site at least three times by now:

“There are very few market indicators that can predict recessions without sending out false positives. The yield curve is one of them.


At a breakfast earlier today, LPL Financial's Jeffrey Kleintop noted that the yield curve inverted just prior to every U.S. recession in the past 50 years. "That is seven out of seven times — a perfect forecasting track record," he reiterated.


The yield curve is inverted when short-term interest rates (e.g. the 3-year Treasury) are higher than long-term interest rates (e.g. the 10-year Treasury yield).


"The yield curve inversion usually takes place about 12 months before the start of the recession, but the lead time ranges from about 5 to 16 months," wrote Kleintop in a recent note. "The peak in the stock market comes around the time of the yield curve inversion, ahead of the recession and accompanying downturn in corporate profits."


The Federal Reserve has been signaling that tighter monetary policy is on its way, which means short-term interest rates should move higher. Is this something we should be worried about? Kleintop offered some context:


How far the Fed must push up short-term rates before the yield curve inverts by 0.5% depends on where long-term rates are. Even if long-term rates stay at the very low yield of 2.6% seen in mid-June 2014, to invert the yield curve by 0.5% the Fed would need to hike short-term rates from around zero to more than 3%.


Based on the latest survey of current Fed members that vote on rate hikes, they do not expect to raise rates above 3% until sometime in 2017, at the earliest…

Lots of economic and market factors drive what happens with interest rates. So the shape of the yield curve is definitely worth paying attention to. "The facts suggest the best indicator for the start of a bear market may still be a long way from signaling a cause for concern," he said.

(emphasis added)

This is it! The holy grail of forecasting, Jeffrey Kleintop has discovered it. You'll never have to worry about actual earnings reports, a massive bubble in junk debt, the sluggishness of the economy, new record levels in sentiment measures and margin debt, record low mutual fund cash reserves, the pace of money supply growth, or anything else again. Just watch the yield curve!

Unfortunately, this advice could turn out to be extremely dangerous for one's financial health. The idea is that the central bank normally begins to hike its administered rate, usually by following rising short term market rates. Long term bond traders foresee that this will sooner or later trip up whatever bubble is underway, and are buying longer term government debt in advance of the event – hence the yield curve as a rule inverts ahead of the bubble's collapse.

Except when it doesn't.


When Perfect Indicators Fail …

The so-called “perfect track record” Mr. Kleintop emphasizes is pretty much worthless once the central bank enforces ZIRP on the short end and has already begun implementing massive debt monetization programs. Here is a chart showing the relationship between 3-month and 10 year Japanese interest rates since 1989, with all six recessions since then indicated:


Japanese yields

Over the past 25 years, the “perfect forecasting record” has worked exactly 1 out of 6 times in  Japan – and that was in 1989 – click to enlarge.


You may wonder what this has meant for stock market investors, so we have added the year-on-year change rate of the Nikkei to this chart. Here goes:


With Nikkei y-y-change

Year-on-year rate of change rate of the Nikkei since 1989. Ouch! - click to enlarge.


As you can see, there were numerous quite strong, playable rallies, interrupted by a series of wipe-outs ranging from 35% to almost 60% – and note, that is just the annual change rate, at one point cumulative losses exceeding 80% from the peak were recorded – in 2009, a full 20 years after the market had topped out!

On occasion of several previous interim lows in the index the cumulative losses from the peak ranged from roughly 65% to 78% (these were: 1992, 1995, 1998, 2001, 2003).

Only the first of the major interim market lows since 1989 (which was actually put in after the least worst decline measured from the peak) occurred after a yield curve inversion.


Nikkei, LT

The Nikkei's manic top in 1989 and its subsequent wild gyrations - click to enlarge.



There is no “holy grail” indicator that can be used to make perfect economic and market forecasts. It is true that if there is a yield curve inversion, it definitely indicates trouble is on the horizon. Alas, we don't remember hearing many real time warnings (in fact, we don't remember any) from Wall Street analysts when such inversions actually occurred in the past (such as e.g. in 1999/2000 and 2006/2007), which makes this new preoccupation especially funny. Obviously, the only time to pay attention to this indicator is when it suggests that a bubble can keep growing!

However, there is no guarantee whatsoever that the yield curve will actually invert prior to the next economic recession and the echo bubble's demise. In fact, looking at  previous ZIRP and QE experiments, we would have to conclude that it is more likely that there will be no such warning at all. 

There is only one thing that is certain: things will continually change. There is no indicator that is fool-proof. If in doubt, one can always consult the Great Zoltar, or alternatively, do the opposite of what Dennis Gartman recommends



Zoltar has been in the forecasting business for a long time. He will know what to do and when.

*  *  *

So we have shown that the 'recessions can't happen unless the yield curve inverts' myth is a fallcy in the US, and everywhere else... yet still, it will be trotted out ad nauseum with carefully selected historical data to show that it is indeed the holy grail... discount appropriately...

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So Close's picture

All your datum are belong to us.

Thomas's picture

Last time the yield curve seriously inverted the bulls declared it a poor indicator. Bulls will be bulls and bears will be bears.

Headbanger's picture

It's laughable that now that the elites have "sold high" they'll let the markets and economies crash to buy low again.


Leonardo Fibonacci2's picture

If Obama hits a 3 pointer in his first basketball shot, the United States will be out of a recession.  Here we go........



old naughty's picture

Zoltar: "Tom, you must grow bigger to dance the floor (fall)."

ugmug's picture

Blame it on Bush....no not that bush. The bush that Google executives take on their yachts to shoot up heroin.



CapitalistRock's picture

People do not seem to understand that when the federal reserve is buying more than half the newly issued treasury debt they can hold the interest rate on those treasuries wherever they please, regardless of what the economy is doing. If you are using US treasuries as your measure of interest rates then you are a fool. Rates on those products can stay at zero even through a hyper inflation.

t0mmyBerg's picture

Agree.  With the Fed injecting itself into everything, there are few good prices left that carry any information.  The idea that the yield curve is a good predictor under current circumstances isnt even worthy of a school childs intellect.  This is one reason ECRI is having such trouble with their leading indicator and recession calls.  Yield curve and stock prices are part of the package.  Which is itself one reason Greenspan blessed the targeting of equity prices.  In the end he wasnt even close to being Randian, just another statist fuck.  Sad

screw face's picture

Zoltar says, 'Zerohedge #FUKU'

nmewn's picture

When all else fails, start counting hookers & blow towards GDP!

"As of September, all European Union countries will be required to take fuller accounting of trade in sex, drugs and other underground businesses as part of an overhaul of economic measurements by Eurostat, the European statistics agency."


Because all illegal activity is well documented & reported to authorities and easily verifiable or sumpin ;-)

Winston Churchill's picture

Why not add drug smuggling ?

Love the way they estimate how much they catch as a %.

Have we reached peak stupidity yet ?

Sure feels like it.Time to acid shock the gene pool.

nmewn's picture

"Love the way they estimate how much they catch as a %. Have we reached peak stupidity yet ?"

I would say so and on the other side of Peak Stupidity is a sheer cliff straight to the bottom...lol.

“These rules say G.D.P. should include everything, even tomatoes grown in your backyard,” Mr. Oneto added. “But sometimes, we can only estimate it. We can’t go around counting the tomatoes.”

Mindless Technocrat: So we just assume everyone grows tomatoes and voila! Our statistics clearly show you can't possibly be starving to death with all those tomatoes you eat!!!

Or are you selling them and not collecting sales taxes for the benefit the fadderland, comrade? ;-)

DaddyO's picture

<-"I would say so and on the other side of Peak Stupidity is a sheer cliff straight to the bottom...lol."->

I would add that a wise man looks ahead and sees danger, a fool rushes headlong to his demise.

The question then becomes, are you wise or a fool?

Rhetorically, of course! lol...


deflator's picture

Because all illegal activity is well documented & reported to authorities and easily verifiable or sumpin ;-)


 I think to be a successful drug dealer or prostitute you would need to declare income and pay taxes on at least enough to cover acquired assets. Can't have millions in assets if you haven't reported more than 35k in any year. A lot of drug dealers end up being prosecuted by IRS for tax evasion rather than DEA on the drug charges. Either way they will take all of your shit.

catch edge ghost's picture

Dang. Who knew it was so simple?

Someone should tell The Fed to stop inverting the curve so there will be no more recessions, ever.

Bunga Bunga's picture

Calm down, in central planning the yield curve is a barbaric relic.

DirkDiggler11's picture

Nice shot by Tyler fired at Dennis Fartman towards the end of the article.

Dennis is my own personal indicator right now, 100% "foolproof" If you trade the exact opposite of his calls. So what if he eventually gets one right, all of his other bogus calls are helping my stacks to grow larger and larger ...

AccreditedEYE's picture

Can't think of any other way to inject Vol into a bank-profit-starved world? Have collateral shortage and beg Fed to release bonds for the "fix"? Sounds like Banksta mischief to me.

Pairadimes's picture

Damn. How many different ways are there to say that the central banks have fucked us?

lakecity55's picture

Hmmm, reminds me of the old Art Clarke story, "The Nine Million Names of God."

ObamaDepression's picture

Great post Tyler(s)!

This is what I love about Zerohedge.

Seer's picture

Only trust the REAL thing: I'm the ONLY true "Seer!"

theonewhowaskazu's picture

I don't really understand why there would be an inverted yield curve in the first place, under ANY circumstance. What's the motivation to lock your money in for 10 years when you could only lock it in for 3 months and get a better return? Or is the logic "illogical thing is happening THEREFORE RECESSION!" 

disabledvet's picture

Best and only trade I have ever made: Alan Greenspan, six month treasury, 2007-2008, "rinse, repeat." Hard to imagine interest rates that high now...but that was one hell of an inversion and it lasted over a year and a half, and it absolutely destroyed Wall Street and the American Middle Class.

It will be impossible to get an inversion for at least 3-5 years...and that is a prediction you can bank on. Simply put the Fed has defaulted to inflation (ZIRP) and now "dual mandate" (taper.). Incredibly while obviously we have inflation...and have had a huge shot of it this past winter...the explosion in production and "efficiencies" (cloud computing, all electric vehicles, etc) has been truly spectacular.

That says to me "just avoid the buggy whip people" (GM, Chrysler, the entire Continent of Europe.) they're trying desperately to create inflation in order to "carry" leverage on, well...in Europe at least a lawn mower might be construed as an asset right now actually.

In the USA we have a STUPENDOUS bubble in the energy patch...and have already seen a wind down of a huge bubble in soft commodities (wheat, corn, soybeans, etc.). Silver and gold are always good...but after the collapse in the Canadian dollar this week...and the fact that the USA in fact is an exporter of oil to Canada!...says to me "look out below."

I still haven't pulled the trigger yet on getting back into equities...but I am chomping at the bit in the "craziest of the crazy places" namely small caps.

The US dollar is still well nigh worthless (especially compared to the euro)...and as Europe's economy plunges into Deep Deflation Adam Smith's LAW of COMPARATIVE ADVANTAGE will come into full force in my view.

That says to me a huge rally in treasuries, inflation protection through the small caps and a continued decline in unemployment to...maybe even as low as 1-2%.

There is no part for the ten thousand M1A1 Abrams Tank that can't be made with a three dimensional printer and a smelter you've installed in your garage for the various metals in that F-150 you've got sitting in your driveway.

Simply put "only the rest of the world needs to worry about where their energy is going to come from."

scubapro's picture



...they wont 'let' it invert, thus denying the Indicator for people to point at.   maybe 5 vs 10; or 7 vs 30 might 'indicate'.

scubapro's picture



...also, the ag commodity wind down--occuring at the same time farmland is/has been bought up like crazy with cheapmoney/leverage.  as prices continue to decline farms will lose money, loans will go bad.  its a slow moving market, so when they foreclose, farms will lie fallow for a year or two as it crashes--even while or if prices climb back up--the banks wont sell the foreclosed property unless they get close to recovering all the losses which takes too much time, which denies farm production, which is analogous to a 'supply shock'.   GMO had a great paper early 2013 about all the hyperinflations and supply shock progenitors.    pre 1929 the farms were alread toast.

ptoemmes's picture

The last recession hasn't ended for those who live in the real world and they are thinking about forecastign the next one?  All they are forecasting are the level of some indicators that have essentially lost all meaning in the new normal FED centrally planned twilight zone that passes for an economy these daze.

What in the hell does GDP mean anymore when for the most part and among other things we do not make much of anything of real economic value and just push electronic bits around like a game of pong?!

Eric L. Prentis's picture

The Federal Reserve is excellent at putting the U.S. economy into a recession---not at keeping the U.S. out of a recession.


ebworthen's picture

Previous indicators/trends/analysis are meaningless now.

We are in uncharted insanity.


lakecity55's picture

B for IS: Hello, China Reserve Bank?


B for IS here. Look, the QE gig the Fed is running is loosing steam. It's your turn to pick up the Ponzi!


lakecity55's picture

Zoltar is back!

Gold and shit, Bit-Chez!

Jackagain's picture

16 Good Reasons To Be Wary Of A Market Downturn - #16 reminds me of 1929...


bugs_'s picture

Ronaldus Maximus told us that when our neighbor loses his job it is a recession and when we lose our job it is a depression.  Apply this important indicator first.

scubapro's picture


that nikkei chart is one of my fav's I show to people that mkts can move w/out 'recessions' or 'reasons' palatable to the common person.  

when it inverts, 7 for 7;  but weve had more than 7 recessions. 

heres to spx at 444, and the gold/dow ratio at 5.  so much potential in both directions coming soon

EBT excepted's picture

You don't have to be Zoltar to figure this one out...I told a co-worker it might be a good idea to take some profits in his 401k.  (looks at me like I've two heads)  He told me he was as aggressive as possible in his allocation.  I asked him "what do you think is making the stock market go up"?  He replied "the current global economic expansion".

Dum head and the whole body suffers...



Edward B.

Miffed Microbiologist's picture

When the ocean recedes and there are flapping fish on the sand, many run in for the easy bounty. The wise run for high ground.

It is tempting to help those who are foolish and blind to their own demise. Make sure you won't be crushed by their stampede or drowned by the wave.


AdvancingTime's picture

Predicting the future is an impossible task, a fools errand, full of pitfalls. Still we listen and soak in all that is said, we even spend a tremendous amount of money to gain an edge in knowing what maybe just around the corner. If you step back ten years in your mind, I suspect that things have not unfolded as you might have predicted. 

When you see how the world has developed, the twist and turns are most unpredictable. Nowhere is this more apparent then in the economy, whether it is in the areas of interest rates and inflation or the rise and fall of companies. Surprise and awe, highlighted with bouts of shock is what we should expect going forward. More on this subject in the article below.