Recession indicator big talk of the day. Here’s what it means.

(Image: screenshot)

Investors scrambled as the Dow dropped 700 points Wednesday following an economic alarm bell that sounded for the first time in over a decade.

A yield curve inversion occurred as the yield on the 10-year Treasury note broke below the 2-year rate, which many saw as a wake-up call that a recession is on the horizon.

(Video: CNBC)

The yield curve “shows how much yield investors are willing to accept to lend the government money,” according to Fox Business.

“Typically, a bond investor receives a higher yield for holding longer-term notes than shorter-term ones. That causes the yield curve to be upward sloping, or ‘steep,’ signaling the economy is getting stronger. It also says investors think they can earn better returns in assets other than Treasurys,” Fox Business explained. “But in some cases, the yield curve flattens, signaling the economy is slowing down and causing investors to shed riskier assets in favor of longer-dated Treasury notes and bonds.”

“You are doing that because you are running away from risk assets, particularly from equities, and that’s what makes you rush into 10-year paper or 30-year paper and that puts the 10-year yield below the 2-year yield,” Sri Kumar, president of a California-based macroeconomic consulting firm, told Fox Business.

The last seven U.S. recessions, going back to 1967, have been preceded by such an inversion.

But some on Wall Street are looking at the big picture and believe the yield curve as an economic indicator is just a “red herring.”

“Markets are too complex to believe than any indicator can be an open and shut case once that indicator becomes widely discovered and gamed by trillions of dollars worth of trades,” Josh Brown, CEO of Ritholtz Wealth Management, told CNBC, noting how fewer eyes were on yield inversions in the 1980′s and 1990′s.

Former Federal Reserve Chairman Janet Yellen doesn’t believe the U.S. economy is advancing toward a recession at all.

“I think the answer is most likely no,” Yellen Told Fox Business on “WSJ at Large” Wednesday. “I think the U.S. economy has enough strength to avoid that. But the odds have clearly risen and they are higher than I’m frankly comfortable with.”

(Video: Fox Business)

Yellen, who was head of the Central Bank from 2014-2018, noted that the yield curve may be influenced by other “factors.”

“So historically, it’s been a pretty good signal of recession and I think that’s why the markets pay attention to it,” she said, “but I would really urge that on this occasion it may be a less good signal.”

“And the reason for that is that there are a number of factors other than market’s expectations about the future path of interest rates that are pushing down long term yields,” Yellen said.

Commerce Secretary Wilbur Ross downplayed the importance of the yield curve as a sure-fire indicator of a recession as well.

“Formulas like that work when they work and they don’t work when they don’t work,” he told CNBC Wednesday.


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