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Source: Federal Reserve Source: Federal Reserve

Historically, the $15.4 trillion U.S. Treasury market has offered one of the most reliable barometers for the health of the American economy. Investors are particularly fixated on what’s known as the yield curve, which depicts the yields on government debt of different maturities at a given point in time.

The curve usually slopes upward as investors typically demand higher returns for locking up their money for a longer period. Occasionally, the curve flips, with yields on short-term debt exceeding those on longer bonds. That’s normally a sign investors believe economic growth will slow and interest rates will eventually fall. Research by the Federal Reserve Bank of San Francisco has shown that an inversion has preceded every U.S. recession for the past 60 years.

U.S. Treasury Yield Curve Data: Compiled by Bloomberg

The U.S. economy is 37 quarters into what may prove to be its longest expansion on record. Analysts surveyed by Bloomberg expect gross domestic product growth to come in at 2.9 percent this year, up from 2.2 percent last year. Wages are rising as unfilled vacancies hover near all-time highs.

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With times this good, the biggest betting game on Wall Street is when they’ll go bad. Barclays Plc, Goldman Sachs Group Inc., and other banks are predicting inversion will happen sometime in 2019. The conventional wisdom: Afterward it’s only a matter of time—anywhere from 6 to 24 months—before a recession starts.

But there are reasons to wonder whether the curve’s predictive powers remain intact. In the wake of the financial crisis, the Federal Reserve not only slashed interest rates, it also bought trillions of dollars in long-term government bonds. At one point in 2017, the purchases pushed down the term premium—the extra bonus investors usually get to hold longer-term debt—on 10-year Treasury notes by a full percentage point, according to one study.

While the Fed began raising short-term interest rates in December 2015, it didn’t start letting the bonds on its balance sheet mature without replacing them until October 2017, and that process is ongoing.

Scott Minerd, global chief investment officer at Guggenheim Partners, says the yield curve remains as reliable an indicator as ever. Photographer: Patrick T. Fallon/Bloomberg

The Fed projects three possible rate hikes in 2019. That on its own could be enough to erase much of the gap between short-term rates and longer-term ones. And if the Fed steps up the pace of hikes, we could more easily see an inversion.

A pair of researchers at the Brookings Institution in Washington caution that inversion may not necessarily be the harbinger of a downturn this time. In an April web post, Michael Ng and David Wessel wrote that the lingering effects of the Fed’s extraordinary bond-buying program could be distorting the curve by weighing down on the term premium. That means “that relatively small increases in short-term interest rates relative to long-term rates could lead to inversion.”

In an Oct. 29 note to clients, Scott Minerd, global chief investment officer at Guggenheim Partners, said that argument is flawed. It fails to recognize that factors such as regulatory changes, including those to money-market mutual funds, and an increase in Treasury issuance have acted in the opposite direction, putting upward pressure on long-term rates. The yield curve, Minerd said, remains as reliable an indicator as ever.