Recession Signals: Why the Yield Curve and Consumer Confidence Matter for Investors

What Consumer Confidence and the Inverted Yield Curve Can Teach Us About Recessions

An inverted yield curve has historically been one of the most reliable indicators of a coming recession, but just like past performance is not an indicator of future results and economic indicators aren’t perfect. There have been several instances when an inverted yield curve did not result in a recession. It is also important to note that historically, recessions don’t occur when the yield curve is inverted, it happens AFTER the yield curve returns to normal. There are a lot of factors at play that can influence if we will have a recession, and how severe that recession might be.

What Does Consumer Confidence Tell Us?

Consumer confidence is another indicator that we like to follow, which is a measure of how optimistic people are about the economy and their personal finances. People tend to spend more money when they feel good about the economy, go figure! When consumer confidence is low people tend to spend less money, take less vacations, or put off making big purchases like a home or car. When a yield curve inverts, it’s a signal that the economy might slow down. Shortly after, consumer confidence usually starts to decline as people sense something is off. And historically, recessions tend to follow. But not always.

Times When an Inverted Yield Curve Didn’t Lead to a Recession

There have been a few notable times when an inverted yield curve didn’t lead to a recession—specifically in 1966, 1998, and 2019.

• 1966: The next recession occurred in 1969 which lasted 11 months

• 1998: The next recession occurred in 2001 and lasted 8 months

• 2019: The next recession occurred in 2020 and lasted 2 months, the shortest on record.

Recessions tend to hit between 6 to 18 months after the yield curve returns to normal, but in these cases, there was another yield curve inversion before the next recession occurred. During these times consumer confidence managed to stay high enough to keep people spending, and that was enough to avoid the economic slowdown that might have otherwise occurred, at least for awhile.

What Fuels a Recession?

When the yield curve returns to normal after inverting, it doesn’t mean the economy is out of the woods. Usually, the yield curve un-inverts when the Fed cuts interest rates. . . and the Fed cuts interest rates because of weakening economic data. The reality is that the Fed has a limited set of levers to influence the economy and they have much more control over short-term interest rates than long-term interest rates. Things that the Fed can do to move short-term rates include:

·         adjusting interest rates

·         controlling liquidity

·         introducing fiscal stimulus.

Wouldn’t it be convenient if we could see the effect of these decisions right away? Unfortunately, the actual outcome of pulling these levers can be unpredictable, feeding into lower consumer confidence. Consumers tend to not like uncertainty. If consumer confidence remains low, people cut back on spending. Businesses, in turn, may reduce investments and cut jobs earnings weaken. We also need to mention pressures in the rest of the world and inflation, all of which create conditions that can push the economy into a recession.

Avoid Emotional Decisions

If you’ve read this far, you probably want to know: What does this mean for my investments?

Here’s the thing—we can’t predict what the economy or stock market will do next, no matter how many signals or indicators we track. And that’s why it’s so important to avoid making emotional decisions. When people see consumer confidence drop or hear bad news about the economy, the gut reaction is often to sell investments or move to cash. But this kind of emotional reaction can be costly, especially if you’re trying to time the market.

Instead, it’s better to focus on the long term.

Conclusion: Focus on Diversification

If the current market environment has you feeling uncertain, it’s a good time to review your financial plan. Ask yourself: Am I properly diversified? A well-diversified portfolio that spreads your investments across different asset classes—like stocks, bonds, and cash—helps manage risk in volatile times. While diversification doesn’t guarantee that you won’t lose money, it does help you weather the ups and downs of the market more smoothly.

At the end of the day, while the inverted yield curve can give us clues about what might be coming, the key to navigating uncertainty is staying focused on your long-term goals. Avoid making rash, emotional decisions, and make sure your investments are set up to handle whatever comes next.

And remember, real wealth is about a lot more than just dollars. If you’re feeling unsure, now is a great time to review your plan and make sure you’re on track. Working with a professional can help, you can read more about how we work for you Here.