{"id":1639,"date":"2019-08-29T06:51:31","date_gmt":"2019-08-29T05:51:31","guid":{"rendered":"https:\/\/sarasinandpartners.com\/row\/think\/yield-curve-inversion\/"},"modified":"2020-05-06T08:36:39","modified_gmt":"2020-05-06T07:36:39","slug":"yield-curve-inversion","status":"publish","type":"post","link":"https:\/\/sarasinandpartners.com\/row\/think\/yield-curve-inversion\/","title":{"rendered":"Yield curve inversion"},"content":{"rendered":"

The recent \u2018inversion\u2019 of the US Treasury yield curve has led to much hand wringing from investors and the financial press alike. Inversion means that the 10-year yield is actually lower than the 2-year yield, in contrast to a normal, \u2018healthy\u2019 upward-sloping yield curve.<\/span><\/p>\n

The brouhaha is to some extent justified, since yield curve inversion has historically been a reliable indicator of a coming recession. In fact, if we exclude the very shallow and transitory inversions of 1973, 1975, and 1998, it has\u00a0never<\/strong>\u00a0sent a false positive. So far, it is too early to say if we are witnessing a \u201ctrue\u201d curve inversion or merely a blip as on those three occasions.<\/p>\n

That said, our preferred measure, which compares the 10-year rate with the 3-month rate (rather than the 2-year rate), first briefly inverted as long ago as March and now stands at a more deeply inverted, and therefore troubling, level of -0.35%. Typically, the curve can invert by up to 1% although prior to recent recessions it has been somewhat less than that.<\/p>\n

Should we be heading for the lifeboats?<\/h2>\n

Not necessarily. Prompt easing action from the Federal Reserve (along the lines of its \u2018mid-cycle\u2019 interventions in 1995 and 1998) may yet ward off disaster. The US has thus far proven resilient to the global malaise, which is concentrated in the tradable goods sector upon which the likes of China, Japan, Korea, Taiwan and the Eurozone are relatively more reliant for growth.<\/p>\n

Even if we ultimately fail to avoid recession, it does not mean that the curve inversion is an immediately sell signal for stocks. It just means that we are in the \u201clate cycle\u201d stage. The end of the cycle only actually arrives when the curve\u00a0dis-inverts<\/strong>\u00a0and begins to steepen rapidly. This is caused by short-end rates declining much more rapidly than long-end rates as investors anticipate an imminent and sharp monetary policy easing cycle in the face of a rapidly darkening economic outlook. The recession of 2007-09 provides a good example:<\/p>\n