Is the most telling sign of a recession here?
This week, we are getting a little technical.
There are things happening in the US Treasury bond market that Aussie investors need to pay attention to.
The traditional indicator of an impending US recession has done something unusual.
That is, rather than just signalling that growth may go backwards, it also flashed that it’s happening ‘rapidly’.
So, it’s time to become familiar with the term ‘inverted yield curve’.
The overly complicated phrase is actually quite simple.
It reflects the direction of interest rates in an economy.
And when the yield curve ‘inverts’, it means that shorter dated government treasury bonds are offering a higher interest rate than longer dated bonds.
This happened back in May with Australian government bonds, although it didn’t last long.
However, it has been happening more frequently in the US.
And the reason why the yield curve attracts so much attention is because once it inverts, it’s often followed by a recession.
At least, that’s been the traditional rationale.
As Jim points out today, it’s not just the inverted yield curve that’s the problem. It’s the relative ‘steepness’ of it.
Is that a good or bad omen for markets? According to Jim, it could be bad news ahead…
Read on for more.
Until next time,
What’s a worse sign than yield curve inversion?
Jim Rickards, Strategist
You’ve seen and heard endless reporting about the ‘inverted’ yield curve and how it’s a top recession indicator.
What exactly does that mean?
The yield curve is just a matter of connecting the dots on a chart, which represents particular yields on bonds of particular maturities.
For example, right now the 10-year US Treasury note has a yield-to-maturity of 2.007% and the 30-year bond has a yield-to-maturity of 2.533%.
If you draw a line between those two yields, you get a curve that slopes upward from left to right as you move to longer maturities.
Normally, the entire yield curve slopes upward from left to right as you move out from three-month bills to 30-year bonds.
That makes sense because longer maturities have more risk of losing money due to inflation or default, so they deserve a higher yield (what’s called the ‘risk premium’).
There’s just one problem: That upward slope is not true today. The three-month bill yields 2.101%, but the five-year note yields 1.768%.
That means the yield curve slopes down from three months to five years before sloping up again to the 10-year maturity and beyond.
That dip in the curve from three months to five years is called an ‘inverted’ yield curve because yields drop instead of rising.
An inverted yield curve is considered a sign of recession because the market is saying the Fed may have to raise rates in the short run (to cool off the economy), but in the longer run rates will be lower (once the recession hits).
But that analysis is unlikely to be true today because the Fed has distorted and manipulated the entire yield curve with its QE and QT policies.
The bear steepener
It’s hard to know how to interpret the yield curve today, except to say the Fed has messed it up and should stop its manipulation.
Is the yield curve telling us anything else?
The answer is an emphatic yes.
In addition to inverting, the yield curve is now steepening, as CNBC writes:
‘Now months after staying inverted, yields on parts of the curve are starting to steepen, or show a greater difference in value, a sequence which could be the true sign of economic trouble ahead, some on Wall Street said.
‘Normally, a steepening would be a sign of higher growth; however, it’s considered a trouble sign when the curve steepening happens because of a more dramatic drop on shorter-term debt yields.
‘“A far more immediate and present danger of recession occurs when after inversion, a rapid steepening occurs. That event usually informs investors the cycle is over and it is time to flee for the hills,” Albert Edwards, a Societe Generale market analyst, said in a note on Thursday.
‘“The final recessionary shoe has now fallen… Rapid curve steepening is now occurring, suggesting recession may indeed either be imminent or else it has already arrived,” he said.
‘“For now what the bond market is doing is signaling the chances of a recession are more likely than the chances of a renewal of the expansion,” said Tom Essaye, founder of Sevens Report Research. “Even though the yield curve is steepening, it’s not giving a very positive sign on the market.”’
Yield curve steepens
This doesn’t mean all rates are going up.
It means the ‘spread’ or difference between short-term and long-term rates is expanding.
That can be bullish (investors expect growth and higher rates) or bearish (investors expect recession and are running for safe-haven assets).
We’ll find out soon enough.
For now, the inversion plus steepening is being taken by some as a sure sign of recession.
All the best,