As the yield curve continues to flatten, investors remain worried about the potential implications for the economy and markets. Why? Inverted yield curves have a perfect history of predicting economic recessions over the past 50 years, with nine of the past nine inversions followed by an eventual recession.
The yield curve is a graphical representation of bond yields of similar credit quality across a range of maturities. A flattening curve, when shorter-term rates rise more quickly than longer-term rates (or fall more slowly), is often perceived as an indication that slower economic growth lies ahead. An inverted yield curve, where short-term rates are higher than long-term rates, has historically been a precursor to a recession.
Last week, the difference between the 2- and 10-year Treasury yields was beneath 0.30%, marking the flattest level since ahead of the financial crisis more than 10 years ago. Here’s the catch: the yield curve isn’t inverted, and we’ve seen periods with a relatively flat yield curve that have lasted years before a recession (the mid-to-late 1990s for instance). With strong corporate profits, high confidence levels, and the benefits from fiscal policy still being felt, we do not anticipate a recession over the next 12-18 months.
But what happens when the yield curve inverts? As our LPL Chart of the Day shows, even inverted yield curves don’t always equal near-term trouble for equities.
According to LPL Research Senior Market Strategist, Ryan Detrick, “Here’s what you need to know: an inverted yield curve isn’t this end-all sell signal that many make it out to be. In fact, looking at the past five recessions, economic growth continued to accelerate for an average of 21 months after the yield curve inverted, and the S&P 500 Index added nearly 13% on average—rising in every instance—before a recession officially started. We aren’t ignoring this potentially troublesome sign, but it doesn’t appear to be the major warning many make it out to be.”
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted.
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The S&P Financials Index is a market capitalization weighted index that tracks the performance of financial companies.
Yield Curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. The most frequently reported yield curve compares the three-month, two-year, five-year and 30-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.
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