Does the Recent Yield Curve Inversion Indicate Economic Downturn? Yield curve inversions have preceded recessions, so is the inversion we’ve seen recently a warning of a crisis? Or is there no clear cut link?
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With direct access trading offered by some online broker dealers, there has been a real surge in popularity of stock trading. But once you enter the stock market, there is always the anxiety of what happens next . While the general mood of investors and the market changes, and can’t always be relied on as an indication of things to come, experienced and intuitive analysts rely on certain charts to draw a pattern and predict whether impending danger is on the horizon. Trade war fears and Brexit concerns have dominated the minds of investors in recent days . Analyst John Jagerson observes that the yield curve has totally been ignored. He points out that there has been a major change in the yield curve that has largely gone unnoticed . This development could alter the outlook for the second half of 2019 and 2020 . What Is the Yield Curve? A yield curve is depicted in a graph where the y-axis represents various bills’ and Treasury bonds’ interest rates, while the x-axis represents the time for those bonds to mature. The interest rates, also called “yields”, usually increase with the longer-term bonds. But longer-term bonds are known to be riskier than the short-term bonds since you have a greater duration of time for which the inflation to take effect and nibble at your principle . But in some cases, you’ll find the interest rates for long-term bonds falling below the rates for short-term bonds, while on rare occurrences you have the long-term and short-term yields appearing similar. The Recent Yield Curve Inversion In a situation when the long-term rates are lesser than the short-term rates, you have the yield curve inverted. This has historically always happened before a recession. On Thursday, the 23rd of May, 2019, the yield curve was significantly pushed into inversion territory. This was more than what has been witnessed since the previous recession. Jagerson attributes this to trade war fears. Jagerson provides a chart where he has subtracted the overnight target rate of the Fed funds (which is the shortest term rate of interest) from the interest rate for the 10-year yield. That
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calculation has been heading to negative territory for a short period, as you can see from the chart. Finally, on May 23rd, towards the end of the chart, it sank below 0.00% quite fast.
Possible Explanations for the Yield Curve Inversion Jagerson looks for an explanation as to why the yield curve goes through an inversion. It could perhaps be that inflation isn’t something investors are worried about since they believe growth in the future would be low. And most analysts really consider it that way. Jagerson also points out another possible factor for the yield curve to head to negative territory the expectation that the Fed could lower the interest rate target for the short term. Bond investors could buy long-term bonds so that the average yield could be high within their portfolio . That inevitably raises these bonds’ prices and pre-emptively lowers the yield. Does This Inversion Indicate Imminent Economic Downturn? Looking ahead, some analysts are of the view that what we’ve seen in terms of yield curve inversion this time is actually different to what we’ve experienced before since the Fed has been quite actively involved in the market since the financial crisis of 2008 . But Jagerson suggests that the fact that the international bond indicators track close to US Treasury yields seems to contradict that theory. www.tradezero.co
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So does this yield curve inversion indicate an upcoming economic downturn? Jagerson has a word of assurance. Even if a yield curve is considered to accurately indicate an economic downturn, it usually happens quite early, at least 10 to 18 months ahead of the recession. Looking back at the 2008 crisis, the yield curve happened nearly two years before that . So, examining the present yield curve, there still is time for investors to prepare before the market gets worse, if this yield curve can be taken as an accurate indication of a market downturn .
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