In Focus – Yield Curve
The 2 to 10-year yield curve inversion:
The yield on the benchmark 10-year Treasury note broke below the 2-year rate, a “canary in the coal mine” scenario that has historically preceded every recessionary environment since 1978. The 10-year Treasury note yield fell as low as 1.574%, briefly trading around 1 basis point below the yield on the 2-year note. Ultimately, the inversion was short-lived with the 10-year treasury yield closing higher than the 2-year.
This phenomenon occurs when two trends emerge:
- The bond markets believe interest rates will fall in the future as the Fed or economic forces attempt to create stimulus
- Investors sell equities and buy bonds, which drives up bond values and therefore pushes longer-term rates down
While certainly concerning, a recession takes an average of 22 months to develop from this indication point.
What does this mean for investors?
Interestingly enough, the inversion of the yield curve is usually followed by gains in the S&P 500. Since 1978, the 18 months following a 2-10 inversion the market rises an average of 15%. This chart shows the last three inversions to the top of the economic cycle.
In addition, the yield curve has always returned to “normal” following each inversion and before each recession.
What’s different this time?
Questions related to the unintended consequences of the Fed’s balance sheet unwinding, previous interest rates hikes by the Fed, negative global bond yields, and the late-stage tax cuts of 2018 are fueling speculation that this yield curve inversion is “manufactured” and harmless. However, a large number of economic data are indicating a slowdown and add credence to the narrative that this inversion is a real warning sign that must be heeded. Both views are likely correct.
What are we thinking?
We are fact-based. The facts are we have a number of economic data points that are concerning – not just the yield curve inversion. However, we are not in a “danger zone” that shows we are at a statistically significant risk of a recessionary market environment with sustained asset value losses, but that could change in the coming weeks based on the level of volatility seen in recent days and the uncertainty surrounding China.
Our opinion is investors should continue to be invested at their comfortable risk tolerance and in-line with the needs of their financial plan. We do not recommend reducing risk below a normal risk tolerance at this stage.
This commentary reflects the personal opinions, viewpoints and analyses of Traverse Planning, dba of Clear Creek Financial Management, LLC, employees providing such comments, and should not be regarded as a description of advisory services provided by Traverse Planning or Clear Creek Financial Management, LLC or performance returns of any Traverse Planning or Clear Creek Financial Management, LLC Investments client. The views reflected in the commentary are subject to change at any time without notice. Nothing on this analysis constitutes investment advice, performance data or any recommendation that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. Traverse Planning and Clear Creek Financial Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results.
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