Chart of the Week : The inverted yield curve
Head of Macro Analysis
Summary: In today’s ‘Macro Chartmania’, we focus on the inverted yield curve. It is known as an ominous indicator of the upcoming U.S. recession. But it is sending a false signal now, in our view.
Click here to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments.
An inverted yield curve occurs when U.S. yields on shorter-dated bonds jump above the ten-year. This is usually the signal that investors expect a deterioration in near-term economic conditions and aggressive intervention from the U.S. Federal Reserve (Fed). Therefore, they want more compensation for loaning money out two years than they do for ten years, for instance. There are at least two yield curves usually watched: the two-year/ten-year spread (the most common indicator used) and the one-year/ten-year (most often mentioned by Fed research papers). Why this matters now: short-term government bonds yields (between three months and five years) have risen more than long ones this year, thus fattening the curve. The curve is not inverted yet. But it follows a steep downward trend. The two-year/ten-years stands now at +45 basis points. It was at +89 basis points in early January. The flattening of the curve partially reflects market expectations that the Fed will hike interest rates several times in the coming months to contain inflation. This is seen by some investors as a bearish signal that the risk of recession is increasing in the U.S. too.
The yield curve inversion has a decent track record to predict a recession. It has successfully predicted all but one of recent U.S. recessions since the 1970s (the only two exceptions are the recession of 1990 and the inversion of 2019 which did not predict anything). But this time is different. The curve is probably sending a false signal, in our view. Massive quantitative easing has depressed the term premium and the long end of the curve is heavily distorted. There are also distortions caused by a preference for safe-haven assets in the current period market by higher geopolitical risk. This preference especially causes higher demand for ten-year Treasury bonds (negative risk premium). The influence of these two factors cannot be ignored. We don’t say that investors should dismiss signals sent by the curve. But they need to be carefully interpreted. There is nothing magical about going to zero. It might happen in the coming months or quarters, but this won’t necessarily mean that recession is about to come. Only a big inversion of the yield curve is likely to be a troubling signal. This is not yet the case.
Latest Market Insights
Q4 Outlook 2022: Winter is coming
- Winter is coming to the financial markets as central banks are tightening their grip. How spring will look is still a question.
European energy crisis: it will get worse before it gets betterThe winter in Europe will be tough, but whether the result is political chaos or sustainable, innovative solutions is still undecided.
A difficult and volatile quarter awaitsAs the year draws to an end, commodities continue to be at centre stage of the world with growth pockets political uncertainty.
The bright side: crises drive innovationThe positive spin on crises is that they come with solutions. It is worrisome that deglobalisation may be a response to this crisis.
Green transformation in China: renewable energy and beyondGoing green, China needs to span numerous energy sources to ensure stability, as every source comes with a challenge.
Asia: Intermittent solutions, but a faster renewable adoption curveAsian energy supply is being squeezed. This and the adoption of renewables may change the investment sentiment in the region.
FX: A Fed thaw needed to deliver a sustained USD turn lowerThe US Dollar can keep momentum when the Federal Reserve continues to tighten, leaving the rest to play to their drum.
Autumn can become ugly for equities and bond holders. Comfort for Dollar longsTechnical analysis suggests that equities could face a tough Q4 as could fixed income. US Dollar positions could provide some upside.
The next stock market sector to watch, with stocks going nuclearAs the world scrambles to find affordable, sustainable energy, nuclear is getting attention from politicians and investors alike.
The crypto space is getting cold when the hype disappearsCryptocurrencies face a winter of their own as retail investors and governments are asking tough questions.