Hoo Boy, Inverted Yield Curve Adds to Stock Market Gloom

For the second time this year, Treasury-based signal flashes: recession ahead. But is this true?

Investors got two—count ‘em—two gut punches Wednesday. To add to the stock market malaise, with the S&P 500 falling to a 12-week low, the Treasury yield curve turned negative.

This marks the second instance in 2019 that a key short-term yield exceeded that of the benchmark 10-year Treasury note. Now, let’s be clear: Once again, this is not the standard inversion, pitting the two-year versus the 10-year. No, this one matches the three-month T-bill against the 10-year.

All quibbling aside, news of the inverted yield curve did not go down well with the stock market. The reason: “The market is saying that a recession is coming,” pointed out Tony Waskiewicz, CIO of Mercy Health (St. Louis), and a well-respected bond savant.

He added, however, that an inverted curve is “just one data point.” Others are needed before it’s clear that a downturn is bearing down on us.

Indeed, there have been seven three-month-10-year inversions since 1966. Six of them turned out to be accurate portents of a recession. But each of those was a case of the shorter-term instrument rising above a mainly static 10-year.

Here, it is the 10-year that is doing the moving. The yield on the three-month, 2.37%, has barely budged since the beginning of May. The 10-year, though, has slid to 2.25% Wednesday from 2.52% on May 1. That’s because, in times of trouble like this one, given the trade war, investors flock to the 10-year, which pushes up the price and pushes down the yield.  

Note that the lone time during the past half-century that there was an inversion because the 10-year moved down was in 1998. Back then, people were freaked over the Russian debt crisis and the demise of mega-hedge fund Long-Term Capital. Reminiscent of now. What’s more, no recession developed in 1998.

Further, odds are that today’s three-month, whose yield tracks the federal funds rate, may be headed downward. That’s assuming the Federal Reserve, which controls the funds rate (current target range: 2.25% to 2.50%), lowers it.

Currently, the futures market places 50% odds on the funds rate being a half-percentage point lower by year-end. If so, maybe this yield inversion is a false alarm.

Related Stories:

Inverted Yield Curve Puzzle: Higher Short-Term Yields
Inverted Yield Curve Warning: Is It Different This Time?
Trade War Could Shove US into a Recession, Morgan Stanley Says

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