Inverted Yield Curve

April 03, 2019

 

Now that the three-month treasury yield is greater than the 10-year treasury yield, we have what's known as an inverted yield curve. The question, when does this reliably predict a recession?

 

Hello, my name is Paul Carroll. I'm the CEO and Founder of Efficient Wealth Management, a boutique wealth management firm in South Texas.

 

Now, ominously, an inverted yield curve has predicted every recession back to the late '60s, but there are some caveats to this. First, the prediction has been as far as two years in advance that's not very helpful, and, two, for the prediction to be reliable, it needs to be inverted. The yield curve needs to be inverted at least for 90 days, a full quarter. Now, that clock started a little over two weeks ago which means it won't be till late June if we know if we have a reliable predictor for a 2020 recession.

 

But what does an inverted yield curve really predict? It's really an accurate prediction for future Fed monetary policy, which can be and has been in the past quite recessionary, but the Fed has quite clearly hit the pause button and made its intentions known. It is probably reacting appropriately for the environment, and we do have the problem of false alarms. We have inaccurately predicted false recessions in the past with this indicator. So I'd like to fondly say the inverted yield curve has accurately predicted five of the last three recessions.

 

So the challenge for investors comes down to one of timing. What, if anything, does this mean for stocks? Two, when does this mean anything for stocks? When do we react? And, three, when do we undo whatever it is, we did to protect our self? Also on the bond side, does this mean we've got to deal with rising interest rates because rising interest rates are bad for bonds. However, we do seem to be in a period of long-term downward systemic pressure on bond yields, especially at the long end.

 

What does this mean for our clients? Well, we have this conversation internally at least every week. We talk about this as we review the investment policy of each and every one of our clients. And if you're not a client, well, maybe we should have a conversation. If you'd like to, all we need is reply to this email or give us a call at 281-528-1200.

 

We wish you the best of investing success in this inverted yield curve environment.

 

Sources:

 “Bond Yields Reliably Predict Recessions. Why?” The Economist, The Economist Newspaper, 26 July 2018, www.economist.com/finance-and-economics/2018/07/26/bond-yields-reliably-predict-recessions-why.

 

Goldberg, Matthew. “What An Inverted Treasury Yield Curve Means For The Economy.” Bankrate, Bankrate.com, 22 Mar. 2019, www.bankrate.com/investing/what-to-know-about-the-yield-curve/.

 

Tagg, Melissa, and Ed Yardeni. “This Is the Real Reason Why the U.S. Economy Isn't in Recession Danger Now.” MarketWatch, MarketWatch, 1 Apr. 2019, www.marketwatch.com/story/this-is-the-real-reason-why-the-us-economy-isnt-in-recession-danger-now-2019-04-01.

 

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