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Art Cashin says relying on the yield curve inversion as a recession signal is 'suspect' this time

Key Points
  • "Usually before a recession, the Fed has been tightening rates so that the short end moves up above intermediate to the longer end," says UBS' Art Cashin.
  • The opposite is happening now, signalling the Fed may not be cutting short-term interest rates enough to keep up with the bond market.
  • Cashin says, "In this case, the longer end moved down to go under the Fed," whose critics says central bankers have created a floor on shorter-term yields.
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Why Art Cashin says the inverted yield curve is 'suspect'

Using the inverted yield curve as a recessionary indicator may not be as reliable nowadays as it's been historically, longtime trader Art Cashin told CNBC on Thursday.

"The inverted yield curve is slightly suspect because this time it's for a separate reason," said Cashin, UBS director of floor operations at the New York Stock Exchange. The difference, he said, is that past inversions came when the Fed was tightening policy, while this has come during a loosening period.

An inverted yield curve, which happens when shorter-term bonds deliver higher yields than longer-term bonds, has preceded every U.S. recession over the past half century.

The 10-year Treasury yield on Thursday remained lower than the 2-year, despite bond yields generally moving higher a day after sinking again to multiyear lows.

Concerns about the U.S.-China trade war, on top of an already slowing global economy, have sent investors running to the perceived safety of bonds, thus pushing yields lower due to their reverse relationship with prices.

"Usually before a recession, the Fed has been tightening rates so that the short end moves up above intermediate to the longer end," Cashin said on "Squawk on the Street."

However, in the current environment, the Federal Reserve is easing monetary policy, not tightening. In July, the Fed cut short-term policy interest rates for the first time in more than 10 years. The market expects, with near certainty, that the central bank will reduce borrowing costs by a quarter point again next month.

Even still, the recent yield curve inversions may be signalling that the Fed is not cutting rates quickly enough to keep up with the bond market.

Cashin said, "In this case, the longer end [Treasury yields] moved down to go under the Fed," whose critics says central bankers have created a floor on shorter-term yields, which allowed longer-term yields to fall right through.

"That's why you have a lot of people calling for a 50 basis point cut, just to deal with the yield curve," he said. Deeper Fed rate reductions would free up shorter-term yields to drop more, which could flip the yield inversion back to normal.