Reassessing the inversion of the Treasury yield curve as a sign of U.S. recessions: Insights from the housing and credit markets

Abstract

Is yield curve inversion a reliable recession signal? Prior research on forecasting recessions investigates the role of the slope of the yield curve, housing, banking, and corporate credit spreads in isolation, without fully considering their interconnectedness. Therefore, we conduct a comprehensive investigation into the ability of house prices, residential investment, bank aggregate liquidity creation (LC) and credit (BC), and corporate credit spreads to forecast recessions. For the 1973–2023 sample, after accounting for the slope of the yield curve, our in- and out-of-sample results show that: i) house prices and credit spreads signal recessions—house prices decline, and credit spreads rise ahead of recession quarters; ii) residential investment’s recession forecasting ability is not as robust as house prices; iii) the recession forecasting ability of LC or BC diminishes when we include other indicators. These findings provide important insights into the interconnectedness among economic indicators and their relationship with recessions. Importantly, we demonstrate that the inversion of the yield curve alone is not the surest sign of a recession. For a recession to occur, house prices must decline, and corporate credit spreads must significantly increase.