Inversion perversion: Why the yield curve may not be a surefire signal of the next recession
Author: Jean Charbonneau
October 19, 2018
When the yield curve inverts, recession happens. Not just sometimes or often, but always based on the past 60 years of U.S. economic downturns.
Source: Bloomberg LP as of October 15, 2018
Given that kind of history, it’s not surprising that many investors have grown anxious about the flattening curve for U.S. treasuries and how long it will be before short-end rates move higher than longer term maturities.
But this time around, the yield curve may not be in such a rush to flip upside down and, because of that, it’s not necessarily the same surefire sign of what’s to come.
In large part, this has to do with the unusual nature of the current economic cycle and past decade of unprecedented monetary policy. Prior expansions, which were marked by low debt and faster growing economies, generally produced much steeper yield curves than has been the case in today’s high debt, slower growing economy. In other words, a flatter curve seems to suit current conditions and may be sustained for a prolonged period of time.
Another key determinant, in this regard, could be the U.S. Federal Reserve’s next few moves. The current Fed projections call for several additional rate hikes over the next two years, which would add pressure at the short end and contribute to further curve flattening.
However, unlike past cycles, today’s inflationary pressures remain relatively benign. As a result, the Fed may be under less pressure to continue at their projected pace and could pause at some point in the future, potentially delaying curve inversion.
Importantly for investors, inverted yield curves, when they do happen, aren’t like a switch that turns off economic growth right away. On average, it has taken several months before eventual economic cycle peaks are reached.
And so with no other real signs that a recession is imminent, fears about the yield curve may be overblown and any market weakness related to it may pose a buying opportunity in risk assets for disciplined investors.
Jean Charbonneau is a Senior Vice President and Portfolio Manager at AGF Investments Inc. He is a regular contributor to the AGF Perspectives blog.
Commentaries contained herein are provided as a general source of information based on information available as of Oct 12, 2018 and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and the manager accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Investors are expected to obtain professional investment advice.
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