Is the US headed for a slowdown or recession in 2025? Know why

Recession in the US: Well, there is a word ‘soft landing’ which became a buzzword at the fag end of 2023, when all economists made a conjecture about the US economy’s soft landing in 2025. 

Since clarity about soft landing is still far away, one thing that made economists jittery is an inversion of the bond yield curve in the US.  

Recently, Canadian Economist Campbell Harvey highlighted the inversion of the yield curve in the US signifying a possible downturn in 2025.  According to him, since 1968, the yield curve inversion has been an indicator of recession and has accurately predicted recessions for eight times, getting eight on eight, and without zero false signals. Harvey's prediction of yields inverted in the fall of 2022, suggests a recession will happen in the first or second quarter of this year.  But is this the case? 

What are bonds, yield, and bond yield curve?

Simply put, a bond is a debt instrument issued by the government and corporations to borrow money. However, a bond yield is the return an investor expects to receive each year over its term to maturity. On the other hand, coupon rate is the annual interest payment paid by the issuer relative to the bond's face or par value.

The bond yield curve, as dubbed by economists and experts, is an accurate traditional indicator of the recession in the US. Since 1950, whenever the bond yield inverted which means the yield on long-term bonds was lesser than the short-term bonds, the recession followed. 

The longer the term of the bond, the higher the yield.  There are different measures of the curve but the difference between the yield of 2-year bonds and 10-year bonds has been inverted since July 2022.  In July last year, the yield on the 10-year bond was at 3 per cent while on the 2-year bond was 5 per cent. 

The inversion of the yield curve means that the yield on short-term bonds is higher than that of longer-term bonds, which is what leads to inversion in the bond yield.

Why is Yield Inversion a worry?

The yield curve is one of the most accurate traditional barometers to predict a recession in the US Market. In the last 70 years, there has been no instance when the inverted pyramid was not followed by a recession. So, inversion of the bond yield curve simply means that the US in 2024 is going to slip into recession.  According to analysts of the bond market, there are chances of the US slipping into recession or economic downturn.

Does yield inversion necessarily signal recession?

This is a million-dollar question. In the past, whenever the yield curve has gone negative or inverted, a recession followed. However, experts and economists clear the fog around the possibility of a recession, they say it is not like a situation where a recession follows immediately after the yield curve inversion. According to the study, it takes 12-14 months for the economy to be in a recessionary phase after the bond yield curve gets inverted.  

However, the economists also believe that inversion itself is not the final call on a recession, as it is sometimes the point when the curve de-inverts, and long-term yields again exceed those of short-term bonds that signal a downturn has arrived. 

Why has the yield on short-term bonds gone up?

But the key question is why the yield on short-term bonds has gone up significantly. The answer lay in increased short-term interest rates by the US Fed. The yield of short-term bonds is linked to the Fed’s short-term policy rate. In today’s environment, the Fed has increased its short-term policy rate to fight inflation, and the yields on short-term Treasury bills have followed suit. The US Fed short-term interest rates have gone up from nearly zero in 2020 to 5.25-5.50 per cent now.  Analysts and experts are expecting a rate cut going forward to insulate the US economy from plunging into an economic downturn or recession. 

A few days back co-founder and former chief investment officer of Pacific Investment Management Bill Gross said that the US Federal Reserve should stop winding down its balance sheet and start reducing interest rates in coming months to avoid recession.