Goldman Sachs says the yield curve isn't signalling a recession this time, but a restrictive Fed policy

  • Goldman Sachs said a key recession indicator isn't signalling a downturn this time.

  • An inverted yield typically tells investors economic weakness is impending.

  • But according to the Wall Street bank, a restrictive Federal Reserve policy is what's driving the inversion.

A key recession indicator isn't signalling a downturn this time, according to Goldman Sachs.

The inversion of the yield curve – when short-dated Treasurys offer a higher return than longer-term Treasurys – is typically seen by investors as a sign of looming economic weakness.

That's because banks, which make money by borrowing bonds at typically low short-term rates and lend them out to businesses at higher long-term rates, have little motive to lend when short-term rates are so high.

The 10-year and 3-month yield curve has been inverted for 212 trading days in a row. That's the longest stretch since at least 1962, Bloomberg data shows.

But fear of a recession isn't what's driving an inversion of the yield curve. In fact, longer-term Treasury yields have jumped as markets price in a lower possibility of an economic downturn, according to Ashok Varadhan, co-head of global banking & markets at Goldman Sachs.

Speaking in a "Goldman Sachs Exchanges" podcast episode, Varadhan said a restrictive Federal Reserve policy is fueling an inverted yield curve.

"The yield curve is less inverted than it has been. So, I'd say over the course of the last two months as the market has basically taken down its probability of a recession," Varadhan said.

"And what I would say is it's inverted because people still feel on a long run basis the policy rate is restrictive. We're in a restrictive place," he added. "And so, people believe that will mean revert over time back to what I said before, you know, sort of a long-term neutral rate of, call it, 3.5 percent. So, therefore, that's what's driving the inversion," he continued.

Goldman dialed back its prediction a US recession in a bullish view compared to the wider markets landscape, recently forecasting that the Fed may appears to have beaten back inflation and skirted an economic slowdown for now.

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