The Yield Curve “Inversion”

 
Asset Management, Fixed Income, Investment Themes, The Economy February 6, 2019

The Yield Curve “Inversion”

The yield curve has been a popular topic of discussion in the media in recent months. During the first week of December, many headlines declared that the yield curve had inverted. Inverted yield curves have generally been reliable indicators of past recessions, so this “inversion” gained a lot of attention. Does this mean we are headed for a recession? The short answer is that the media is focused on the wrong part of the curve and although the yield curve is flattening, we have not seen a true inversion yet. In normal economic periods, the yield curve slopes upward as longer bonds yield more than shorter bonds. Currently, short-term rates, which are controlled by the Federal Reserve, are rising faster than longer-term rates, creating a flat yield curve.

In early December, the yield on the 2-year Treasury was about 0.02% higher than the yield on the 5-year Treasury. The media highlighted this relationship as an inversion, but not only was the differential very small, it was likely a short-term trading aberration. The 2-year and 5-year also “inverted” in 1998, but this inversion was not followed by a recession. Generally, the relationship between the 2- and 10-year yields is a better indicator of a recession. At a spread of 0.18 percentage points, the 2-year and 10-year are close, but still in positive slope.

Historically, the probability of a recession doesn’t increase until the yield curve becomes substantially more inverted than a few basis points. The case for focusing on yield curves in the U.S. is based on the fact that they have made few false recession signals and many correct warnings. Still, it is unclear why the curve should matter, or which gap matters most.

 

 

Individual investment positions detailed in this post should not be construed as a recommendation to purchase or sell the security. Past performance is not necessarily a guide to future performance. There are risks involved in investing, including possible loss of principal. This information is provided for informational purposes only and does not constitute a recommendation for any investment strategy, security or product described herein. Employees and/or owners of Nelson Roberts Investment Advisors, LLC may have a position securities mentioned in this post. Please contact us for a complete list of portfolio holdings. For additional information please contact us at 650-322-4000.

Receive our next post in your inbox.

More from the Blog

Economic Outlook Extends Video

Read More

Expansion Outlook Extends

Read More