Yield Curve Inversion
I wanted to talk this week about what a yield curve inversion is and why it is important. I thought it might be helpful to provide information and insight on what this means for the economy and investors. According to Reuters, an inverted curve means:
“The inversions suggest that while investors expect higher short-term rates, they may be growing nervous about the Fed’s ability to control inflation without significantly hurting growth. The Fed has already raised rates by 300 basis points this year.
The U.S. curve has inverted before each recession since 1955, with a recession following in six to 24 months, according to a 2018 report by researchers at the San Francisco Fed. It offered a false signal just once in that time. That research focused on the part of the curve between one- and 10-year yields.”
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.
It is important to note that an inverted yield curve tends not to immediately suggest a recession is at hand. Since World War II every yield curve inversion has been followed by a recession in the following 6-18 months.1
We Believe In This Indicator
At Destination Wealth Management we still believe an inverted yield curve is an important clue to future economic growth. Regardless of whether a recession is imminent 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 unexpected surprises in the markets and economy. This impacts how we invest portfolios. Paranoia is one of our investor traits.
If you have any questions about this information, please let us know. Always here to help.