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Are bond traders better than economists?

| Posted by: Paul Donovan | Tags: Paul Donovan Weekly

  • Long-term bond yields in the US may fall below short-term interest rates. That is an inversion of the yield curve. Some people think this a recession signal. In the past, recessions have hit a year or two after a yield inversion. Are bond traders better than economists at predicting the future?
  • The myth that bond markets predict recessions never really worked outside the United States. It is unlikely that US bond markets have predictive powers that other bond markets lack.
  • Using yield curves to predict US recessions worked in the past. When inflation rates were high, inflation was the most important part of the bond yield. In the past, inflation was strongly linked to economic growth. When bond investors expected lower growth, they would expect lower inflation. Lower inflation would drive bond yields lower. If investors expected lower growth, the yield curve would invert.
  • Now, inflation is low, and not as important to bonds. Real yields are more important. A large part of US inflation is made up of nonmarket prices, which are not linked to the economic cycle. Bond markets tell us some things about the economy. This does not include whether a recession is coming.