The European Central Bank cautioned against reading too much into a bond-market metric often regarded as a harbinger of recession.
(Bloomberg) — The European Central Bank cautioned against reading too much into a bond-market metric often regarded as a harbinger of recession.
The predictive power of an inverted yield curve — typically seen to herald a downturn — has been reduced in recent years by central bank bond buying, the ECB said in its account of its July monetary policy meeting.
The purchases have weighed on the so-called term premium, according to the ECB. That’s the additional yield component that investors typically demand to compensate for the risks of holding longer-dated bonds.
For months, those arguing that economies were headed for a recession have pointed to the inverted yield curves in the US and Europe, to support their view. The thinking is that investors flocking to long-dated bonds, and thereby driving rates below short-term tenors, expect borrowing costs in the future to fall as the economy slows.
Germany’s yield curve between the two and 10-year tenors is currently inverted by around 50 basis points, off an early July low that was deepest inversion since 1992. Almost every US recession since 1955 has been preceded by such a curve shape, though by mid-2023, the downturn had failed to materialize. The US Treasury yield curve has been inverted for more than a year.
The ECB acknowledged in its account that an inversion in euro area yields “had reignited recession concerns among market participants,” particularly given the track record for such a move.
Read more: What an Inverted Yield Curve Means for Recession Odds: QuickTake
Still, “owing to the stock effect of the central banks’ bond holdings, the term premium remained compressed, which could reduce the predictive content of the slope of the yield curve for economic growth,” it said.
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