Building with curves.

My Thoughts on the Yield Curve

Many are speculating about a potential recession because of an inverted yield curve. I am not so sure. Economic activity is strong, balance sheets are still in good shape.  While every recession was foretold by an inverted yield curve, not every inversion has resulted in a recession. Mental shortcuts aid in this misunderstanding and may cause investors to jump to the wrong conclusion. Here are my thoughts on the yield curve:

Just like with tornadoes. You can’t get tornadoes without wind and rotation. But that doesn’t mean every time we have wind and rotation; we get a tornado.

I am hesitant to say this time is different – it almost never is. But since the inverted yield curve is not an accurate predictor of recessions, it may make sense to understand why this is happening when the economy still seems to be trucking along at a decent pace.

Historically, long-term bond yields are lower than the short term is because people think the economy is doing poorly and that economic growth is going to slow. I am not sure that is the case this time.

I think it is possible longer-term bond yields are dropping due to their bargain relative to foreign bonds. Many countries offer their 10-year bonds at a negative interest rate. That’s right – people are paying money to invest in bonds. Why would I buy a 10-year German Bund at a yield of -0.70% (that’s a negative), when I could buy the safest and most liquid asset in the word, a 10-year US Treasury yielding 1.55%?  That is a difference of 2.25%.

Perhaps we are seeing Treasury bond yields decline because there is a significant global demand for them. Maybe it has nothing to do with an expectation of a slowing economy.  Maybe not.

With investing, sometimes we just don’t know. But to jump to the conclusion that an inverted yield curve means a recession is imminent (and we better get to cash) is irresponsible. Slow down, and stick with the plan. As with all investment decisions, we should deliberately consider the information available, and not just what the media is spewing. And oftentimes, the best decision in the heat of the moment is to turn off the TV and go do something you enjoy.

 

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