Yield Curve Conversion
If you listen to my KCBS interview, you will hear me briefly describe what a yield curve inversion is and why it is important. I thought it might be helpful to provide additional information and insight on what this means for the economy and investors.
A normal yield curve is characterized by short-term rates that are lower than long-term rates. In other words, when a one-year treasury pays 1% and a five-year treasury pays 2%, that is the normal yield curve. The longer the maturity, the greater the interest paid.
An inverted yield curve is characterized by long-term rates that are lower than short-term rates; the opposite of the normal yield curve. It is a rare occurrence and tends to be one that investors pay attention to.
An inverted yield curve suggests bond investors believe the economy in the future will be worse than it is today. An inverted yield curve does not cause a recession but is often seen as an indicator that a recession might be coming in the future. In the last 12 recessions, 9 times the recession has been preceded by an inverted yield curve.
It is important to note that an inverted yield curve tends not to immediately suggest a recession is at hand. In fact, the average time a recession emerges is well over a year after an inverted yield curve indicator.
Janet Yellen, the former chair of the Federal Reserve, suggested this week that an inverted yield curve this time may not be as dire an indicator as it has been in the past. Most inverted yield curves come with problems in the housing market and rising unemployment; that currently is not the case. While the housing market is certainly softer than it was last year, it does not appear headed for an implosion. The employment picture is even less problematic as unemployment rates remain at historic lows.
At Destination Wealth Management we still believe an inverted yield curve is an important clue to future economic growth. We put the odds of a recession in the next 12 to 18 months at about 40%. The odds will rise if the China trade disagreements march on. We believe if China trade challenges are resolved the odds of recession will begin to fall.
Regardless of whether a recession occurs or not, we are believers that overall growth will be slower on the long-term because of rising deficits and slowing global GDP expansion. We have positioned portfolios on this somewhat sober perspective. We invest based on the assumption that there will always be an unexpected surprise in markets and the economy is prudent. This impacts how we invest portfolios. Paranoia is one of our investor traits.
We have already positioned strategies on the assumption of a slowdown in economic growth. We continue to make adjustments based on our belief that it is prudent to make portfolio adjustments given current conditions. We will continue to do so.
If you have any questions about this information, please let us know. Always here to help.