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Economic Outlook: Difference between revisions
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# If investors see higher odds of a recession, the long-term inflation risk premium in Treasury bonds will fall. In recent recessions, the risks of unexpectedly low inflation have increased relative to the risks of unexpectedly high inflation. This is explain because in periods of low inflation, the fixed nominal cash flows from a nominal bond become more attractive, driving up the prices of these bonds and lowering their interest rate. | # If investors see higher odds of a recession, the long-term inflation risk premium in Treasury bonds will fall. In recent recessions, the risks of unexpectedly low inflation have increased relative to the risks of unexpectedly high inflation. This is explain because in periods of low inflation, the fixed nominal cash flows from a nominal bond become more attractive, driving up the prices of these bonds and lowering their interest rate. | ||
# If investors see greater risk of recession, they will attribute higher value to short-term assets that they can easily liquidate to finance spending on goods and services. Hence, they will require higher compensation to keep holding long-term securities. This means a yield curve inversion in this escenario is an expectation of lower odds of a recession. | # If investors see greater risk of recession, they will attribute higher value to short-term assets that they can easily liquidate to finance spending on goods and services. Hence, they will require higher compensation to keep holding long-term securities. This means a yield curve inversion in this escenario is an expectation of lower odds of a recession. <span style="color:red">Last sentence unclear</span> | ||
Due to these contradictory reasons, not all yield curve inversion will signal a recession, thats' why is important to understand the current enviromnent we are in and the sentiment among inversions. Since several surveys has been done recently already, especially the latest Philadelphia Fed survey of professional forecasters showing the probability of a recession in the next year is the highest in the 50+ years this survey has been conducted<ref>https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q4-2022</ref>, we can conclude that this time investors are pricing in mostly higher odds of a recession in the yield curve inversion. | Due to these contradictory reasons, not all yield curve inversion will signal a recession, thats' why is important to understand the current enviromnent we are in and the sentiment among inversions. Since several surveys has been done recently already, especially the latest Philadelphia Fed survey of professional forecasters showing the probability of a recession in the next year is the highest in the 50+ years this survey has been conducted<ref>https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q4-2022</ref>, we can conclude that this time investors are pricing in mostly higher odds of a recession in the yield curve inversion. | ||