But prolonged inversion could make a recession more likely
Even if we are right, we have to be wary that an inverted yield curve driven by recession fears can potentially be self-fulfilling. Banks typically borrow short term and lend longer term so when the yield curve is inverted the interest rate received on assets could be lower than what they pay on their liabilities.
So far there is little evidence that the flattening and subsequent inversion of the yield curve is feeding through into reduced credit availability
This will hit profitability and could decrease risk tolerance, which implies tighter lending standards. Indeed, when asking banks about this for the Federal Reserve’s Senior Loan Officers report, the write up concluded an inverted yield curve would be interpreted as ‘signalling a less favourable or more uncertain economic outlook and likely to be followed by a deterioration in the quality of existing loan portfolio.’
So far there is little evidence that the flattening and subsequent inversion of the yield curve is feeding through into reduced credit availability (certainly not if you look at today’s mortgage lending numbers), but that could change if the inversion persists. A scenario of much tighter credit conditions would clearly add to the headwinds facing the US economy and heighten the chances of a downturn. It’s difficult to see the Fed not bowing to the markets’ will and cutting rates more aggressively in such an environment.
In this regard, the Federal Reserve’s Jackson Hole symposium 22 -24 August will be the next thing to focus on.