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Why the Yield Curve Inverts in One Simple Picture - Mish Talk

08 December 2018

An "inverted yield curve" has often predicted past economic downturns.

The greenback, which started the week on a weak footing as the apparent thaw in trade tensions between the USA and China cooled demand for the safe-haven currency, extended its fall as investors anxious about the inversion of the short end of the US yield curve in bond markets.

Stuart Canning, research analyst at M&G Investments, has said the temporary yield curve inversion which saw three-year Treasury yields lower than two-year notes is a signal that interest rates in the United States may need to come down in the near-term. When the economy is healthy and investors are forecasting good times ahead, they generally demand higher yields for Treasurys that mature a decade or more into the future than those maturing in a year or two. The yield curve has flattened as continuing interest rate hikes send short-dated yields higher, while longer-dated Treasuries are supported by tepid inflation and slowing global growth.

For the most comprehensive local coverage, subscribe today. On Monday, the yield on the five-year Treasury note slipped below yields on shorter-dated three-year notes, according to a report in Bloomberg. That spread has been narrowing in recent days, and on Tuesday fell to 0.12 percentage points, the lowest since the 2007-2008 crisis, fueling a stock sell off.

No, at least not yet.

If that inversion happens, investors should prepare for a potential US recession as soon as mid-2019. But most economists say the chances of a near-term recession are slim, pointing to strong hiring and consumer spending, among other positive trends. It may take two rate hikes or more for that portion of the curve to invert. They pay much more attention to the spread between two-year and 10-year Treasury yields.

As reported by Bloomberg, a yield curve inversion of the 3- and 5-year US Treasuries is flagging a growing warning sign, and could be signaling for the key pre-recession yield inversion of the 2- and 10-year yields.

The Dow Jones Industrial Average fell 701.59 points, or 2.72 percent, to 25,124.84, the S&P 500 lost 76.6 points, or 2.75 percent, to 2,713.77 and the Nasdaq Composite dropped 239.86 points, or 3.22 percent, to 7,201.65.

Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

The Cleveland Fed, meanwhile, has focused on the difference in yields between three-month Treasurys and 10-year Treasurys. That particular inversion has preceded every recession since the late 1970s.

At 3:29 p.m. EST (2029 GMT), the 10-year Treasury yield shed almost 8 basis points, to 2.915 percent, after hitting its lowest level since September 7.

Global equities have been shaken as a flattening U.S. Treasury yield curve fans worries about a recession, and on growing doubts that Washington and Beijing will be able to clinch a substantive trade deal during a temporary cease-fire agreed at the weekend. He's a finance professor at Duke, and the man who first demonstrated that the yield curve can act as a recession predictor.

Why the Yield Curve Inverts in One Simple Picture - Mish Talk