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2023.09.18 07:59
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Goldman Sachs: Inverted yield curve does not necessarily mean a recession in the United States, because "this time is different"

According to Dolphin Research, the asset-liability ratio of the Federal Reserve is now an order of magnitude larger than it was in 2006. Given the current short-term policy interest rates, the yield curve should be flatter. In other words, adjusting for the size of the balance sheet, the degree of inversion in the yield curve will decrease, and may even exhibit a positive slope.

Although "this time is different" may be the five most dangerous words in macroeconomics and the market, Morgan Stanley still insists that "this time is different" and the inverted yield curve of US Treasury bonds does not necessarily mean that a US recession will follow closely.

As a well-known contrarian indicator, the inverted yield curve of US Treasury bonds has always been regarded as a precursor to an economic recession. Currently, the real yield and real GDP growth in the United States are similar to the levels before 2008, while the bond yield curve is steeper, with the 2-year Treasury yield 70-100 basis points higher than the 10-year yield. Many market analysts believe that the severity of the yield curve inversion indicates an economic recession in 2023.

However, Matthew Hornbach, Head of Global Macro Strategy at Morgan Stanley, pointed out in a report on Monday:

Compared to the past, an increase in fiscal deficits will bring stronger economic growth and more government bond supply. We believe that earlier this year, when the market anticipated government bond supply, market yields already reflected this view. Recent technological innovations have also brought higher productivity, which is different from the phase after the 2008 financial crisis, which some people called the "stagnation period."

Regarding why "this time is different," Hornbach pointed out that the inverted yield curve amplifies the actual situation, and based on the adjusted size of the balance sheet, today's real yields may be much higher than in 2006. Therefore, he believes that the inverted yield curve cannot accurately predict future economic recessions.

One of the reasons why we did not associate the steeply inverted curve with an imminent recession is the size of the Federal Reserve's balance sheet. The scale of securities held by the Federal Reserve plays an important role in determining the shape of the yield curve under a given short-term policy rate. The larger the proportion of government bonds held by the Federal Reserve in the outstanding bond market, especially those with longer maturities, the flatter the yield curve.

Today, the Federal Reserve's balance sheet is an order of magnitude larger than in 2006, and under the given short-term policy rate, the yield curve should be flatter. In other words, after adjusting for the size of the balance sheet, the degree of inversion of the yield curve will decrease, and it may even become positively sloped.

At the same time, the size of the balance sheet not only affects the shape of the yield curve, but also should suppress real interest rates. Comparing today's real yields with those in 2006 overlooks an important issue in terms of its magnitude.