How to Predict Recession

Yesterday the world got to know that the 2013 Nobel Prize in economics was awarded to Eugene Fama, Lars Peter Hansen and Robert Shiller for their "empirical analysis of asset prices". According to the awarding committee, their work had "laid the foundation for the current understanding of asset prices".

And then we came up with our new viz of the day in which we actually empirically try to find the answer to the question: How to predict economic recession?

The analysis of yield curve may help to predict upcoming economic recession. Yield curve shows how interest rates of debt (usually government bonds) change with the increase of its term to maturity.

Usually it is considered by investors that lending money for the long term is more risky than lending for the short term, as it is harder to make any predictions for the longer time horizon, i.e. how the world will change say in 10 years. That is why long-term interest rates are usually higher than the short-term ones. Note, "usually" means “in good times” or when people have somewhat robust expectations about near future.

However, when looking to the history we can reveal that before all economic recessions short-term (ST) interest rates became higher than the long-term (LT) ones (the difference between LT and ST is negative). It means that people feel uncertain about economic situation in the near future expecting economic downturn while the in the long term they expect recovery (as it usually occurs in business cycles) and require less rate of return for the long-term investments. So, when you see that ST interest rates become higher than the LT ones you may be almost sure that the economic recession is anywhere near.

On the line chart below the difference between monthly interest rates of 10-years US Treasury Bills (long-term) and 1-year US Treasury Bills (short-term) is shown over the time horizon from April 1953 to August 2013.

View full dashboard

No comments:

Post a Comment