Wednesday, 12 December, 2018

This Market Indicator That Frequently Signals a Recession Just Flashed Red

Going out of business sign An inverted yield curve almost always presages a recession
Rhonda Young | 06 December, 2018, 07:57

Lyngen said the inversion of 3- and 5-year yields has increased the likelihood that an inversion of the 2- and 10-year yield will happen in late 2018 or early 2019. But when investors are anxious that growth will fall off sharply, perhaps as a result of the Federal Reserve pushing short-term rates higher, they're willing to accept less in interest for a Treasury maturing far in the future.

What exactly is a yield curve, and why is it inverting?

Generally, short-term bonds carry lower yields because the investment is considered less risky, whereas longer dated funds should have higher yields to reflect that an investor's money is at more risk as you commit for more time.

US two-year Treasury yields rose above three-year Treasury yields on Tuesday for the first time in more than a decade as traders piled on bets the Fed might be close to ending its rate-hike campaign.

Instead of just reflecting investors losing faith, Fed officials have argued that the recently narrowing gap between short- and long-term Treasury bonds could reflect long-term shifts in global capital flows, or the fact that all interest rates are lower and more compressed together than they used to be. The spread between the 10-year yield over its 2-year counterpart also shrank to the smallest since the start of the financial crisis in January 2008, signaling to some investors an approaching United States economic slowdown.

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Signals from the Federal Reserve last week that it may be nearing an end to its three-year rate hike cycle has pushed the 10-year U.S. Treasury yield to three-month lows below 3 percent.

No, at least not yet.

"Inversions tend not to be particularly dramatic, so the intraday event is more of a technical milestone than breaching a level in outright yields", wrote Ian Lyngen, head of US rates strategy for BMO Capital Markets.

Market watchers also say they won't get anxious until a more important part of the yield curve flips.

The dollar sagged in the wake of falling Treasury yields, with its index against a basket of six major currencies briefly stooping to a near two-week low of 96.379 overnight before edging back towards 97.00.

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The bad news for investors is that inverted yield curves have preceded each of the past nine US recessions.

The Dow Jones Industrial Average fell 799.36 points, or 3.1 percent, to 25,027.07, the S&P 500 lost 90.31 points, or 3.24 percent, to 2,700.06 and the Nasdaq Composite dropped 283.09 points, or 3.8 percent, to 7,158.43. Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab. The central bank is projected to raise rates by another quarter-percentage point in December, even as investors are uncertain if the central bank will slow down its hiking path. That is to say, almost everyone is convinced the two-year to 10-year if not the 3-month to 10-year spread will invert. An inversion in that part of the curve has preceded each of the last seven recessions.

According to the Cleveland Federal Reserve, an inverted yield curve has preceded the last seven US recessions.

Asian stocks slid on Wednesday, dragged down by Wall Street's tumble as sharp declines in long-term U.S. Treasury yields and resurgent trade concerns stoked investor worries about global economic growth. Inverted yield curves have historically occurred during periods of economic recession.

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