When Will the Next Recession Happen?

As you may know, a treasury bond is a financial instrument issued by the government as a way to borrow money from the public. It’s likeĀ  Uncle Sam saying, “Hey, folks, I need some cash to fund all the amazing things we’re doing, so lend me your hard-earned dough!” When you invest in a treasury bond, you’re essentially becoming a creditor to the government. You lend them a certain amount of money for a fixed period of time, and in return, they promise to pay you back the principal amount along with periodic interest payments.

Think of it as a long-term relationship between you and the government, where they act as the trustworthy borrower and you act as the savvy lender. Treasury bonds are considered one of the safest investments out there because they are backed by the full faith and credit of the government. This means that the chances of the government defaulting on their payments are extremely low. So, when you invest in a treasury bond, you’re not only supporting the government’s financial needs, but you’re also securing a reliable and relatively low-risk investment option for yourself. It’s a win-win situation that allows you to earn some interest while contributing to the functioning of your nation’s economy.

Curve Your Expectations

The yield curve spread is a powerful financial tool that provides insights into the health of the economy and the expectations of investors. To understand it, let’s picture a roller coaster ride of interest rates. The yield curve represents the relationship between the interest rates of bonds with different maturities. Now, imagine this curve stretching and bending like a thrilling coaster track. The yield curve spread refers to the difference, or the spread, between the interest rates of long-term bonds and short-term bonds.

Why is this spread so important, you ask? Well, buckle up because here’s where it gets exciting! The yield curve spread acts as a crystal ball, offering clues about the future direction of the economy. When the spread is wide, with long-term rates significantly higher than short-term rates, it suggests a rosy outlook. Investors are confident about the future and expect economic growth. On the other hand, when the spread narrows or turns negative, with short-term rates exceeding long-term rates, it’s like a red flag waving in the air. This inversion of the yield curve could indicate troubled times ahead, like an economic storm brewing. So, by keeping a close eye on the yield curve spread, investors, economists, and financial wizards gain valuable hints about the twists and turns of the economic landscape.

Curve Inversions and Recessions

Would you believe it if I told you that an inverted yield curve has predicted all 10 recessions since 1955? Believe it or not, it is completely true! The 10-year curve subtracted by the 2-year curve is the gold standard when it comes to Treasury Yield Spread. The spread has been used to predict recessions for over 70 years. Once the yield spread turns negative, a recession will soon follow.

What you will notice is that the bottom of the inversion (red vertical line) always precedes the start of the recession (blue vertical line).

10-year US bond minus the 2-year US bond curve always bottoms before a recession.

What the Data Shows

The data speaks for itself; the spread must start to un-invert from its bottom before we get a recession. In essence, there is a bit of a “lag”. Here is the data from the last four recessions:

A chart showing the lag between the bottom of the 10-year/2-year spread and the start of the ensuing recession for the past four recessions. The average lag time is 10.25 months.

As you can see, the average lag between the bottom of the 10-year/2-year spread and the start of the ensuing recession has been on average 10.25 months over the last four recessions.

Keeping that in mind, it looks like the 10-year/2-year curve is finally starting to un-invert, meaning that there is a very good chance that we get a recession within the next 12 months. Using this data, one can expect a recession in 2024 Q1/Q2.

Time is of the Essence

The information regarding treasury bonds and the yield curve spread has implications for the real estate industry. Real estate is a sector heavily influenced by economic conditions, and the yield curve spread can provide insights into the future direction of the economy, which in turn affects the demand for real estate.

A wide yield curve spread, indicating higher long-term rates compared to short-term rates, suggests an optimistic economic outlook with expectations of growth. In such a scenario, the real estate industry may experience increased demand as investors and homebuyers are confident about the future and willing to make long-term investments. This can lead to higher property prices and a thriving market.

On the other hand, a narrowing or negative yield curve spread, where short-term rates exceed long-term rates, raises concerns about economic uncertainty and potential recessionary conditions. In such situations, the real estate industry may face challenges. Homebuyers and investors might become more cautious, delaying or scaling back their real estate transactions. Reduced demand can result in stagnant or declining property prices, longer listing times, and a slower overall market.

Considering the current un-inversion of the 10-year/2-year yield curve and the possibility of a recession within the next 12 months, the real estate industry should prepare for potential shifts in market dynamics. Monitoring the yield curve spread along with other economic indicators can help real estate professionals and investors make informed decisions and adapt their strategies accordingly.