What does the yield curve inversion mean for equities? What does the yield curve inversion mean for equities? What does the yield curve inversion mean for equities?

What does the yield curve inversion mean for equities?

Equities 7 minutes to read
Peter Garnry

Head of Equity Strategy

Summary:  Much has been made of the yield curve inversion's potential to signal recession. Here, however, we zoom in a little from the macro view and look at what it means in terms of equity returns.

On Friday, the US 10-year Treasury yield dipped below the three-month Treasury bill yield for the first time since 2008, when the financial crisis was unfolding at full speed. The yield curve inversion has received a great deal of attention, and we have also covered it in our equity updates and presentations, in addition to this week's Morning Calls.

Aside from the discussion surrounding how precise it is as a recession indicator, the question for equity investors is what does it mean for returns?
Yield curve inversion
US 3M/10Y yield spread in % (source: Bloomberg, Saxo Bank)
Our analysis of yield curve inversion on the three-month/10_year shows that 18-month S&P 500 forward returns are highly negative with the average being -7%. In three out of the 10 observations, the S&P 500 is up 18 months after the yield curve inverts for the first time, so investors should take note of last Friday's events and not downplay their significance. Even with only 10 observations, it should still set your prior to a negative expectation (we then update our views based on incoming data).
S&P 500
If we plot the time evolution of the S&P 500 from the point at which the yield curve inverts, we see a more nuanced picture. There are two periods that support a more sanguine approach: in both 1998 and 2006, the 3M/10Y inverted but the S&P 500 continued up by 38% and 22% respectively. In both cases, the yield curve inversion did predict an economic recession and stock market decline, but it came with an 18 month-plus delay. In both periods, the yield curve stayed inverted and the subsequent 18 months returns in the S&P 500 starting in April 2000 and July 2007 were losses of -30% and -45% respectively.

What the chart below shows is not only the variance in returns, but also that the timing of the yield curve inversion is difficult. But the evidence is strong enough to warrant caution now in US equities.

Should the Fed react as it did 1998 when Russia’s default and LTCM spooked the Federal Open Market Committee, then we may very likely see an interest rate cut this year (the market is already pricing it in with a high probability). This rate cut, together with fiscal impulse in both the US and China, may be enough to extend the expansion – and the bull market – for another two years, just like in 1998.

We are not at all confident about that scenario. We can easily see clear paths leading straight from last Friday's inversion to equity price declines. But the timing is difficult to gauge, and that's why this market is so difficult.
S&P 500
Our analysis is carried out by taking the time series for US 3-month T-bill and 10-year Treasury yields on weekly observations. When the spread inverts, we start our observation and lock it for 18 months so we don’t get overlapping observations creating auto-correlation in our analysis. If the yield spread remains inverted after 18 months, we lock in another 18 months of S&P 500 returns . Since 1962, this gives us 10 independent observations with the 11th having started on Friday.

Saxo Capital Markets (Australia) Limited prepares and distributes information/research produced within the Saxo Bank Group for informational purposes only. In addition to the disclaimer below, if any general advice is provided, such advice does not take into account your individual objectives, financial situation or needs. You should consider the appropriateness of trading any financial instrument as trading can result in losses that exceed your initial investment. Please refer to our Analysis Disclaimer, and our Financial Services Guide and Product Disclosure Statement. All legal documentation and disclaimers can be found at https://www.home.saxo/en-au/legal/.

The Saxo Bank Group entities each provide execution-only service. Access and use of Saxo News & Research and any Saxo Bank Group website are subject to (i) the Terms of Use; (ii) the full Disclaimer; and (iii) the Risk Warning in addition (where relevant) to the terms governing the use of the website of a member of the Saxo Bank Group.

Saxo News & Research is provided for informational purposes, does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. No Saxo Bank Group entity shall be liable for any losses that you may sustain as a result of any investment decision made in reliance on information on Saxo News & Research.

To the extent that any content is construed as investment research, such content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication.

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments.Saxo Capital Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Capital Markets or its affiliates.

Please read our disclaimers:
- Full Disclaimer (https://www.home.saxo/en-au/legal/disclaimer/saxo-disclaimer)
- Analysis Disclaimer (https://www.home.saxo/en-au/legal/analysis-disclaimer/saxo-analysis-disclaimer)
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)

Saxo Capital Markets (Australia) Limited
Suite 1, Level 14, 9 Castlereagh St
Sydney NSW 2000

Contact Saxo

Select region


The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-au/about-us/awards

Saxo Capital Markets (Australia) Limited ABN 32 110 128 286 AFSL 280372 (‘Saxo’ or ‘Saxo Capital Markets’) is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms, Financial Services Guide, Product Disclosure Statement and Target Market Determination to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Saxo Capital Markets does not provide ‘personal’ financial product advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Capital Markets does not take into account an individual’s needs, objectives or financial situation. The Target Market Determination should assist you in determining whether any of the products or services we offer are likely to be consistent with your objectives, financial situation and needs.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website is not intended for residents of the United States and Japan.

Please click here to view our full disclaimer.