Inverted yield curve warning

Posted By Darren Winters on Apr 2, 2019


Inverted yield curve warning

The inverted yield curve warning where short term bond returns more than the long term bonds suggests an upcoming recession.

The inverted yield curve warning indicator has a fairly accurate track record of predicting recessions and it flashed red last month

Capital flows out of stocks and into safe havens such as the 10-year treasuries cause the yield curve to invert March 22.

The yield curve“ flipped” before the Great Recession and it did it again last month, March 19 where a treasury bill which matures in three months is yielding 2.45% percent, 0.02% points more than the yield on a Treasury that matures in 10 years.

The inverted yield curve warning is worth keeping on your investor’s radar

Inverted yield curve warning

This warning signal is like the investor’s crystal ball.

A rule of thumb is that when the 10-month Treasury yield falls below the three-month yield, a recession usually hits in about a year. The inverted yield curve has preceded each of the last seven recessions, according to the Federal Reserve Bank of Cleveland.

In theory, what the inverted yield curve warning tells us about investor’s behavior is that demand for long term bonds, for example, the 10-year treasuries is more attractive than say dividend yields stocks. Rising demand for long term bonds causes the price to rise and their corresponding yields to fall.

So the yield curve, which graphs the short term and long term bond returns, inverts when long term bond yields fall below that of short term bond yields.

See a graphic example of an inverted yield curve

Put simply, the inverted yield curve warning is the writing on the wall which reads pending recession. Bond investors (who are considered the world’s most astute investors) are losing confidence in the economy’s prospects.

But could investors be overreacting to the economic data which is triggering the inverted yield curve warning?

A raft of economic indicators are flashing red.

The brick-and-mortar meltdown was a theme in 2018 with many dubbing the sector’s woes as the retail apocalypse.

The retail sector woes show no signs of abating and are now spilling into 2019. The latest events of the retail apocalypse suggest that the rate of retail closures is still climaxing.

“The first quarter of the year is just coming to a close, and retail has already lost 41,000 jobs for the year, and that doesn’t even include March. That is 92% more than the number of retail jobs lost during the same period of 2018, which was worse than in 2017. So, the rate of closures is still climaxing,” according to a piece in Zero Hedge entitled, “Retail Apocalypse Closing Stores Down Like Death of Dinosaurs.”

The ongoing retail apocalypse is not solely due to the transition of retail online

The data suggests that overall retail (including online) did not do well in the final quarter of 2018.

So the inverted yield curve warning is in-tune with the downturn in household consumption.

Moreover, the latest consumer credit suggests that the world’s largest consumers are tapped out. The average American has a credit card balance of $4,293, according to the latest Experian data.

US consumer credit hit a massive $22.5 billion in November which resulted in US consumer credit reaching its all-time high of $4 trillion.

Auto and student loans contributed the most to US credit blowout. A record $1.593 trillion in student loans outstanding with auto debt also hitting a new all-time high of $1.155 trillion, an increase of $9.5 billion in the quarter. \

So the world’s largest consumers are diving deeper into the red to finance their spending.

Consumption propped up on credit is unsustainable in the long run so the inverted yield curve could be a warning that credit and the economic cycle has peaked

The recent collapse in the shipping rates could be further evidence of a slowing global economy which could also be rotating capital into long term bonds and causing the inverted yield curve warning.

The Baltic Dry Index is down by almost 50% year to date at 689 (April 1). Moreover, “bellwether” stocks earnings have peaked which could be another indicator of a slowing economy.

But perhaps it was the Fed’s patience to pull the reins of its monetary normalization policy that has pivoted investors into the dovish camp and caused the inverted yield curve warning.

The market is pricing in no more rate hikes for at least 2019. So the Fed’s transition from tightening to accommodation is also a clear sign that the economic cycle has peaked.

The inverted yield curve warning could live up to its reputation as being an accurate gauge for predicting the next recession

If so, the next recession is due to hit late 2019 early 2020 just in time for the US elections.

But this time the economy sails into the storm with fewer life rafts, bearing in mind that “normalization” has ended with Fed fund rates at 2.5% and 3.2 trillion dollars of assets on its balance sheet.

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