The United States' Longest Inverted Yield Curve Could Soon Come to an End. Implications for Stocks.
The inverted yield curve, the primary recession indicator for the financial market, appears poised to break its record of continuously flashing warning signs.
That might be excellent news for markets, if there isn’t a subsequent recession.
The longest period of time this has occurred—522 days—is when returns on a 10-year bond have been less than those on a 2-year bond. This is a significant oddity because investors should receive better profits for keeping debt for longer periods of time. This phenomenon, referred to as the yield curve inversion, frequently portends more challenging economic times to come.
When the difference grew to about 50 basis points by June—the biggest in 2024—there were few indications that the inversion was slowing down.
However, a reversal has been occurring. The difference between the 10-year Treasury yield and the 2-year yield at the end of Friday’s trading session was just 7.6 basis points, or 0.076 percentage points, the smallest since July 8, 2022.
Since July, Treasury yields have decreased across the board in anticipation of a rate cut by the Federal Reserve in 2024; market odds on a rate cut in September have reached 100%. Bond prices rise and yields decrease in an inverse relationship between interest rates and bond prices.
Friday saw more declines in yields as concerns about a recession grew due to an increase in unemployment. Economists were concerned that the Fed may have acted too slowly and forecast further more rate cuts for 2024.
“By the end of the week, we hope to see the 2s/10s curve return to positive territory,” stated Ian Lyngen, chief U.S. rates strategist at BMO Capital Markets, last Friday.
This contains both good and negative news. The S&P 500 has gained 83% of the time in the six months following the conclusion of an inversion, according to Dow Jones Market Data. This is based on six occurrences since 1977 where an inversion lasted at least 50 trading days.
Though the odds are evenly split in the three months following an inversion, it is up 67% of the time in the 12 months that follow.
According to research, stocks have increased by 2.6%, 8.3%, and 12% on average during the last three, six, and twelve months soon after a protracted inversion has concluded.
The good news ends there, for the most part.
According to David Rosenberg of Rosenberg Research, “everyone is excited about the prospect that the 2s/10s curve is set to pivot to a positive slope.” The issue is that this actually indicates the need for rate reductions and coincides with slowdowns in the economy when it occurs after an extended period of inversion.
In actuality, recessions have been almost certainly anticipated by yield curve inversions. Five of the six recessions that have occurred since 1980 began with an inversion that lasted at least 20 days. A six-day long inversion in August 2019 signaled the start of the sixth recession, which was linked to COVID-19 in 2020. That is to say, recessions can happen long after an inversion has finished.
Investors should take note that this inversion has lasted longer than any previous, so when and if it ends, it will be unlike any other, which adds uncertainty to expectations about market performance.
Nor will its conclusion signify the end of recessionary concerns. There has never been an easy way to time the inversion. The first signal is similar to a ticking clock that indicates the beginning of issues; however, it is unclear when the troubles will cease.
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