The yield curve is considered one of the better indicators to determine where we are in the economic cycle. Historically, a yield curve inversion in the U.S. has often been followed by a recession. If yield curves contain information about future economic growth, they may also predict future stock and bond returns.
We evaluate the ability of the yield curve slope to forecast future economic conditions, as well as returns on stocks and bonds, using over 50 years of data across six countries. While the yield curve slope has reasonably consistent predictive ability for next year’s economic growth, both within and across countries, it has not been a very reliable market timing indicator. Instead, it may be more useful as one signal (among many) for cross-country allocation decisions in stock and bond markets. The current mild U.S. curve inversion is a bearish signal for these markets, but alone we believe it is not a compelling reason to take large bearish positions.
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We thank Paras Bakrania, Jordan Brooks, Antti Ilmanen, Thomas Maloney and Zachary Mees for their work on this paper. We also thank David Kupersmith, Toby Moskowitz, Chris Palazzolo, Scott Richardson, Ashwin Thapar, and Dan Villalon for their helpful comments and Ing-Chea Ang for research assistance.
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