In layman's terms, if we have compressed economic activity all around for months together, we are in a recession.
These are usually strong contributing reasons for a recession.
Now let's move from causes to correlations.
Usually, when the yield curve inverts, it precedes a recession by 6-18 months. If you don't pretend to be smart or not an economics nerd, here is where I'd expect you to close this essay and switch to Netflix. Who wants to be told on a Sunday that they aren't smart. That's why I read what this means. Stay with me. It's easy.
Let's break the term down: 'Yield' and 'Curve'. Yield simply means what you get back for the money you put in bonds. If you expect the economy to grow, you'll keep the money for a longer time in the bonds (or at least the part that you allocated for bonds). If you expect uncertainty, you will keep it for a shorter duration and cash it out at the end of the (short) duration. If every bond investor prefers short term bonds over long term ones, the yield for short term ones becomes more than long term ones.
Let's look at the curve. Short duration, low yield. Long duration, more yields. So this when you plot, resembles a flight take off – Low altitude (yield) in the beginning (of time). What's happening now is a preparation for landing – we are still mid-air. So the altitude (yield) is high but everyone expects a landing shortly. The curve will be that of a flight landing. Are you with me?
Now let's look at the curve (It beats me why no article on yield curve actually has the curve. Show me the rainbow if you describe the rainbow!)
The above chart simply says that if the yield difference between short term and long term bond yields are zero or negative (Y-axis), it is a good indicator of an upcoming recession. We are not there yet but the 3-month yield curve has already inverted (not shown in this graph).
So ultimately, it's just what everyone thinks. If the world thinks we are in a recession, we are – not spontaneously but over a period of time, as the mood catches on. That mood reflects over 6-18 months after bond traders start trading more in short term, high yield bonds. The stock market may agree or disagree but once the consumer spend falls, it becomes a moot point and everyone ultimately commits to acknowledging that we are in a recession.
To be clear, we are not in a recession but technically I will never be wrong in predicting one because there is always one that will come. What is not known is if it's 6 months or 18 months away.
I prefer another leading indicator that is closer home for us folks in the world of eCommerce.
Both top retailers and top DTC brands are seeing a decline in traffic growth rate. But this curve has inverted for the last 6 months, indicating a cool-off in eCommerce growth post-pandemic.
A cool-off is not bad. We had phenomenal growth in the last years. So we need to look beyond just traffic. The consumer sentiment index has been falling too and it's the lowest in a while.
I have more charts to throw. The 'Visa Spending Momentum' charts are trending above 100 (which means there is no slowdown in spending yet). Retail footfalls are increasing. That partly explains the eCommerce growth cool off.
We are going to study some more charts and indices deeply in the coming two weeks and present an 'eCommerce Economy' report.
Until then, here is a working theory if you need a short version:
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