ResearchOctober 30, 2019

The Yield Curve Un-Inverts: Time to Celebrate?

Opinions differ on whether this change to a widely followed recession signal means the heat is off.

Reported by Larry Light

The yield curve, which inverted last spring to Wall Street’s horror, has switched back to its old pattern lately.

That’s important because an inverted yield curve is a signal of an impending recession. This augury has proven true through time, with an exception or two. The recession doesn’t have to follow right away, mind you, just happen along in a year or so after the curve inverts.

The natural order of finance is for longer-maturity Treasury securities to pay more than shorter-term ones. After all, the longer you hold a bond, the greater the odds that things could go wrong. Like a ruinous inflation could hit in five years, blasting the value of your 10-year Treasury note.

The curve in question involves the three-month Treasury on the short end, and the 10-year on the long. According to Treasury Department statistics, on Oct. 10, the three-month’s yield had dipped to 1.68% and the 10-year’s yield had risen to 1.67%, almost neck and neck. The next day, the re-inversion occurred, with the three-month staying the same, and the 10-year climbing to 1.76%. As of Tuesday, the spread had widened still more, to 1.63% for the three-month and 1.84% for the 10-year.

Certainly, they still are pretty darn close. They may revert to an inverted curve. The likely reason for their switcheroo is that the Federal Reserve is expected to lower its short-term benchmark today, putting downward pressure on the three-month. And investors are easing away from the 10-year, which they view as a haven security in scary times. Instead, they’re putting their money into stocks, which are riskier but rising amid the current optimism over the US-China trade clash.

The broader perspective about the yield curve is that the spreads are tellingly narrow. This betokens something awry in the inverting universe. That’s the position of Campbell Harvey, the Duke professor who first spotlighted an inverted curve as a recession signal.

“One thing that’s very important is that my model links the slope of the yield curve to economic growth or future economic growth,” Harvey told Business Insider. “And frankly, whether the yield curve’s flat or slightly upward sloping or inverted, all that means the same thing. It means low growth.”

Opinions differ, of course. James Paulsen, chief investment strategist at Leuthold Group, thinks the danger may well be diminished. As he wrote on his blog, “a return to the positively sloped free-market curves suggest recession risk has been lessened.”

Not abolished, of course. But for those who need a little good news, this will do.