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