Inverted yield curve is no cause for panic....yet

By Colin Twiggs
March 29, 2019 7:00 p.m. ET (10:00 a.m. AEDT)

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10-Year Treasury yields continue to fall. A Trend Index peak below zero signals strong selling pressure (purchases of bonds). Target for the decline is primary support at 2.0%.

10-Year Treasury Yields

The spread between 10-Year and 3-Month Treasury yields is at zero, warning that the yield curve is about to invert. While there is no cause for panic, an inverted yield curve is a reliable predictor of recession within 12 to 18 months, preceding every recession since 1960*.

*1966 is an arguable exception. Initially classed as a recession by the NBER, their decision was later reversed and airbrushed out of history.

10-Year minus 2-Year Treasury Yields & Bank Credit

The 10-year/3-Month spread last crossed below zero in August 2006 and was followed by a recession in December 2007. While credit conditions tighten when the yield curve inverts, there is considerable lag and the chart below shows that credit growth remains high while the yield curve is inverted.

Yield Curve Inversions & Bank Credit

A far more imminent warning (of recession) is when the yield differential recovers above zero.

Why does a recovering yield curve warn of impending recession?

First, you need to understand what causes the yield curve to invert. Economic prospects weaken to the extent that bond investors are prepared to accept lower long-term yields than the current short-term yield, in anticipation that interest rates will fall. The inverted yield curve will continue for as long as rates are expected to fall but will rapidly recover when the Fed starts to cut rates.

Treasury Yields

Falling short-term yields flag that the Fed is cutting interest rates, confirming bond investors earlier suspicions of a weakening economy. That serves as a reliable warning, after an inverted yield curve, of impending recession.

We are not there yet. The Fed may have eased off on further rate rises but is still some way off from cutting rates.

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Colin Twiggs is director of The Patient Investor Pty Ltd, an Authorised Representative (no. 1256439) of MoneySherpa Pty Limited which holds Australian Financial Services Licence No. 451289.

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