Should Investors Be Concerned About Yield Curve Inversion?

December 06, 2018 | Ben Mohr, CFA, Director of Fixed Income

After eight post-recession Fed rate hikes since 2015, the U.S. Treasury yield curve continues to flatten. On Monday, December 3, the yield curve inverted by one basis point between the three-year yield at 2.84% and the five-year yield at 2.83%. The next day, that inversion intensified to two basis points, with the three-year yield at 2.81% and the five-year yield at 2.79%, causing an 800-point correction in the Dow. The bellwether steepness indicator — the difference between the two-year yield and 10-year yield — remains upward sloping, however, but narrowed from 15bp on Monday with the two-year at 2.83% and 10-year at 2.98% to 11bp on Tuesday with the two-year at 2.80% and 10-year at 2.91%.

Based on previous market cycles, an inverted yield curve has predicted a recession six months to two years after inversion. Prior to the 2008 crisis, the first sign of inversion occurred in the 4th quarter of 2005, when the three-year and five-year inverted first, followed by the two- and ten-year inverting in the same quarter, roughly two years before the crisis that began in early 2008. This week’s chart shows the actual yield curve at the end of the day on December 4, along with the predicted yield curve at the end of this year and the next three years based on Treasury forwards. We can see that the market expects the curve to be generally upward sloping for the rest of this year, but to further invert in the front of the curve to the belly, and remain inverted in that region, for the next three years. However, the market still shows the 10s minus 2s to be upward sloping, even in the outer years.

Over the last few quarters, the expectations for the Fed’s hikes declined from one this December plus four more in 2019 to one this December plus only one more in June 2019. With this first sign of inversion, the Fed may pause on a hike for December, but it has communicated the hike so much that it may have to move forward with it or risk a loss of credibility. As 2018 heads to a close, this recent inversion bears watching and will no doubt have an impact on this month’s as well as next year’s capital markets.

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The opinions expressed herein are those of Marquette Associates, Inc. (“Marquette”), and are subject to change without notice. This material is not financial advice or an offer to purchase or sell any product. Marquette reserves the right to modify its current investment strategies and techniques based on changing market dynamics or client needs.

Ben Mohr, CFA
Director of Fixed Income

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