Pakistan’s yield curve inversion signals recession warning

August 21, 2024 (MLN): Pakistan’s yield curve has been inverted for 20 months, the longest in at least two decades. The inversion, where yields on longer-dated bonds are below those on shorter-dated bonds, is widely recognized as one of the strongest recession indicators globally.

Recently, however, amid falling inflation and economic stability, Pakistan has experienced a sharp decline in shorter-term bond yields. The 10-2 yield curve spread which was inverted by almost 600 basis points in September 2023 has dropped steeply to 193 basis points, the least inverted in over 1.5 years.

However, this may not be cause for celebration, as the yield curve often dis-inverts when a recession is about to begin.

Historically, in the U.S., a negative 10-2 yield spread has occurred 6-24 months before the actual recession and is thus seen as a far-leading indicator.

It has accurately predicted every U.S. recession since at least 1968.

To note, curve dis-inversions occur either due to changes in long-term rates, known as the ‘bear steepener,’ or due to falling short-term rates, known as the ‘bull steepener.’ Pakistan is currently experiencing the latter, which is more common.

It is worth mentioning that Campbell Harvey, who developed the yield curve indicator, has said, “My yield-curve indicator has gone code red, and it’s 8 for 8 in forecasting recessions since 1968 — with no false alarms.”

Harvey in a Bloomberg interview earlier in January this year added, “I have reasons to believe, however, that it is flashing a false signal.”

The Bull Steepener

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