“The yield spread between the 2-year and 10-year Treasury Note has narrowed to 25 basis points, its smallest spread since 2007. This has many investors worried the narrowing spread will lead to an inversion of the yield curve…
[But] Nominal GDP (real growth plus inflation) grew 4.7% in the four quarters ending in March, and looks to have grown even faster in the four quarters ending in June. At 2.83%, the 10-year Treasury note yield is 187 basis points below nominal GDP growth. For comparison, over the past 20 years (1997-2017) – the 10-year Note yield averaged just 43 basis points less than nominal GDP growth. In other words, today’s spread is substantially – and we think unsustainably - larger than its 20-year average.
Nominal GDP growth is a good proxy for a “natural or neutral” rate of interest because it’s the average rate of growth in the economy – a reasonable proxy for investment returns. Some companies grow much faster than GDP, some grow much slower.
… More importantly, the economy is accelerating, and the Fed is chasing both rising real growth and rising inflation. Even if the Fed lifts rates to 3.5% by the end of 2019 (which would require six more rate hikes at the current pace), the Fed will still not be tight relative to nominal GDP growth. So, the odds of a recession in the next few years remain very low even if we get a technical inversion."
(Yield Curve Inversion dated 07/16/2018 by Brian Wesbury, Chief Economist, Robert Stein, CFA & Dep. Chief Economist, and Strider Elass, Senior Economist, with First Trust Advisors LP)
Full report can be found here:
https://www.ftportfolios.com/Commentary/EconomicResearch/2018/7/16/yield-curve-inversion