Do Yield Curve Inversions Predict Recessions in the Euro Area?

Abstract

Based on monthly data from 1970 to 2022 and the AUROC performance metric, we show that yield curve inversions generally predict recessions in the euro area. However, there are two important limitations. First, the forecasting capability of the yield curve has tended to weaken since the global financial crisis. Second, the overall performance is driven by eurozone core countries, especially Germany. Risk premia, and more particularly the credit risk component, blur the relationship between the yield curve slope and the probability of a future recession within the so-called periphery countries.

Keywords: Recessions, yield curve, AUROC, euro area, risk premia

JEL Classification: C25, E37, E43