The bond market yield curve is inverted — which some economists think foreshadows a downturn
The bond market yield curve is inverted — which some economists think foreshadows a downturn
Humans have been fortune-telling for at least six thousand years — there’s tarot cards, palm reading and the bond market.
A 10-year bond theoretically locks up your money for 10 years in exchange for some yield or other. Is that yield worth it? It depends on what the future looks like: inflation, interest rates and “the long term growth potential of the U.S. economy,” according to Steve Laipply with BlackRock.
In good times, the bond market follows a pattern. You can graph it — this is what is called the yield curve. Longer term bonds like 10-year treasuries typically have higher yields than short term bonds like the 2-year or the 3-month. Partly, this is just because people want a little extra return for locking their money up for longer. And partly it’s because the future looks bright.
But sometimes, everything gets turned upside down. The longer term bonds start showing a lower return than the short term bonds, otherwise known as inversion. That is what is called an inverted yield curve, where the yield is higher for the short term treasury than the long term treasury. Usually, that is a very bad thing.
Keeping all that in mind: this week, two-year treasury notes hit a 16-year high, and are now at 4.929%, which is almost a whole percent point higher than the yield on the 10-year treasury.
“Inversions predate a recession anywhere from six to 18 months,” said Steve Blitz with TS Lombard. Short term bonds represent the present — when the Fed is raising rates. Long term bonds show a dark and terrible future where the Fed is lowering rates because the U.S. is in recession.
“Inflation expectations are expected to remain firm,” said Matthew Luzzetti at Deutsche Bank. “Growth is expected to remain resilient, the federal reserve is likely to be raising interest rates.”
But there’s a little more to an inversion. “It’s not like it’s a middle-aged talisman, like a whale washing up on the beach and you get seven years bad luck,” Blitz said. “There’s something real going on in the marketplace.”
The economy sours on making long-term investments, and sticks with low-risk, short-term ones.
“People are being compensated more to take no risk,” Blitz said.
Enough people do that and it starves the economy of credit, creating an economic slowdown, he said. So the inverted yield curve isn’t just a prophecy, it can be a self fulfilling one, too.
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