Should We Even Care If the Yield Curve Inverts?

Long touted as an augury of recessionary misery ahead, an inverted yield curve may not actually be the best at forecasting. And it seems like another inversion will soon test that thesis.

The yield curve is currently flirting with becoming inverted, a condition that’s most often defined as when the yield of the 10-year Treasury bond drops below that of the two-year. Right now, they are separated by a microscopic amount. At 3.48%, as of Tuesday’s market close, the 10-year is just four basis points higher than the two-year.

For more stories like this, sign up for the CIO Alert newsletter. 

The last time an inversion occurred was in April, but the curve quickly un-inverted and the spread widened again. While brief inversions have happened this week, they only lasted a matter of hours.

In recent days, short-term rates, more sensitive to the Fed’s tightening campaign, have moved up a lot further than has the longer bond’s yield. Analysts say that owes to last week’s alarmingly high Consumer Price Index report, which could prompt the Fed to get even more aggressive.

Since World War II, the average is five years between recessions, according to National Bureau of Economic Research data. But the intervals can vary considerably. The positive economic period between the Great Recession and the 2020 pandemic downturn was about 10 years.

While yield curve inversion might be a reliable indicator of a recession, the question is: when? The wait time between a curve inversion and a recession’s onset has averaged about 22 months, NBER data show. For the last six recessions, the interlude has ranged from six to 36 months—that’s three years.

While yield curve inversion might be a decent indicator of a recession somewhere up ahead, it isn’t a very reliable market timing tool, wrote Anu Gaggar, global investment strategist for Commonwealth Financial Network, in a report. If you dumped your stocks the moment an inversion happened, and then sat on the sidelines while the market kept rising, you would not be happy.

As the previous inversion this year was over quickly, John Lynch, CIO of Comerica Wealth Management, made the point in a report that a “prolonged inversion is required” to be a sure signal of recession.

The inversion need not be constant to portend a recession, notes Daniel Phillips, director, asset allocation strategy at Northern Trust Asset Management. From 2006 to 2007, the inversion “went in and out,” he recounts in an interview. The recession arrived in December 2007.

There was also a 2019 inversion seemingly predicting the next year’s slump—although, Phillips says, it could not have anticipated the pandemic’s U.S. arrival in early 2020, the development that really triggered the two-month 2020 recession. The 2019 inversion was more centered on the U.S.-China trade war than a worldwide plague, he says.

Sometimes, inversions take place without a recession following, such as in 1966. Should one that lasts more than a few days crop up in the near future, we may indeed be staring down at an economic chasm.

Spreads Are Narrowing: Could We Get (Gulp) an Inverted Yield Curve?

The Yield Curve Un-Inverts: Time to Celebrate?

Tags: 10-Year Treasury, Federal Reserve, Great Recession, Inverted Yield Curve, NBER, Pandemic, recession, Trade War, Two-year Treasury

A new report from the Association of Canadian Pension Management, a pension advocacy group, aims to help pension plan administrators understand their fiduciary duties and implement an appropriate strategy relating to environmental, social and governance factors.

The ACPM report provides several recommendations for ESG legislation, regulation and reporting that it says would provide more clarity for pension plan administrators.

For more stories like this, sign up for the CIO Alert newsletter. 

“The administrators of Canadian pension plans are fiduciaries with significant duties that include investing pension fund assets so that pensions are secure and provide the promised benefits,” says the report. “How pension plans can and should account for ESG risks in light of the fiduciary duties applicable to pension fund investing is an issue that pension plan administrators globally are struggling to manage.”

The report calls for regulatory guidance to be provided for plan fiduciaries on how and to what extent ESG should be considered regarding their legal fiduciary duties, and for minimum pension standards legislation to define ESG factors and expressly authorize ESG considerations in investment decisions.

The ACPM report also says that any ESG reporting guidance should be principles-based and that reporting should be clear, transparent, consistent and not too burdensome, particularly for small pension plans. The report adds that ESG reporting requirements should recognize that most Canadian pension plans do not invest assets directly and typically work with consultants to choose institutional asset managers.

“Detailed reporting on ESG by pension plan administrators will only be relevant and useful if downstream ESG reporting is uniform and consistent,” says the report. “Only once there is comparable disclosure across the investment industry will pension plans be able to effectively disclose appropriate sustainability metrics.”

The report says ESG reporting at the company level should follow consistent global standards, and calls for the creation of a sustainability disclosure framework for the investment industry that includes input from key stakeholders, including regulatory bodies and institutional investors such as pension plans. It also notes that there is a “significant disparity” among pension plans in Canada regarding how ESG decisions are made, as well as in their ability to effectively implement those decisions. Additionally, the report says, Canadian pension legislation provides no definition of ESG factors or considerations.

“A one-size-fits-all approach to regulation has the potential to impose a significant burden on the administrators of small plans, member directed DC plans or plans with limited ability to control or influence their asset manager’s implementation of a desired ESG approach,” says the report.

And for member-directed defined contribution pension plans, the report says, it is important for sponsors to identify investment options in each asset class on the DC platform, understand the level of ESG integration in their fund options and develop an ESG member communication strategy.

However, the report stresses, plan administrators must understand and assess the implications of addressing ESG factors; like all governance decisionmaking, they must be done prudently and in the context of the particular plan.

“Pension plan administrators may consider ESG factors in investment decisions provided that any such investment is in the best financial interest of the beneficiaries and that their decision is rationally based on evidence after appropriate due diligence,” said the report. “Such investments based on ESG factors would not be a breach of trust or a violation of the plan administrator’s fiduciary duties.”