On March 22, we witnessed an event that hasn’t occurred since 2007: an inverted yield curve. The yield on the three-month U.S. Treasury bill crept slightly higher than the yield for a 10-year U.S. Treasury.
What this means, in the minds of some, is that a recession is just around the corner.
We don’t dismiss the significance of the yield curve: It is one of many data points we monitor closely, and our portfolio is well-diversified and positioned for uncertain times. However, this latest inversion, while rare, doesn’t rise to the level of inversions that preceded recessions in the past. Many other economic indicators are strong.
In December we outlined six reasons why we didn’t forecast a recession for 2019. The yield curve, which had not inverted at that point, was at the top of our list. Now that an inversion has occurred, why not amend our outlook?
The duration of the inversion is key: The inversion that occurred on March 22 was short-lived. On April 1, for example, the yield on the 10-year Treasury was 2.444 percent, while the yield on the three-month T-bill was 2.401 percent. That spread was fairly flat, but it wasn’t inverted.
As we noted in December, there have been seven times since 1976 when the yield curve was flat or inverted, with an average duration of 10 months. Five of those times, recession followed, as soon as nine months later, as long as 22 months later. Twice, inverted yield curves did not result in recession. The two times when no follow-on recession occurred, the inversions periods were short (1-3 months). History shows that we need an inversion lasting three months or more before it is a sign of likely recession, and even then, recession tends to come 17-20 months later.
The March inversion involving the three-month Treasury didn’t meet the historical standard needed to qualify as a recession flag.
There has been no inversion involving the two-year Treasury: Our preferred measure for the yield curve is with the two-year Treasury and the 10-year Treasury. The two-year is a better reflection of the state of the economy, we believe, because three-month T-bills tend to be very anchored by the Fed Funds Rate. While the spread between the two-year Treasury and the 10-year Treasury is narrow—and has been for quite some time—there has been no inversion. That suggests that recession talk is premature.
We monitor yield curves closely, but it is important to keep an eye on other factors as well.
The Fed has idled its interest rate hikes: When the Fed tightens to check inflation worries, the yield curve tends to flatten and eventually invert, as near-term inflation pressure and Fed tightening put upward pressure on short rates, while the long-end of the curve prices in slower growth due to the contraction of credit. In September of last year, the Fed suggested it could raise rates two or three times in 2019, but it has not done so. On March 20, the Fed signaled that no hikes were anticipated for 2019. There is some consensus that the Fed made one tightening move too many, and now some traders are betting on one rate decrease this year.
Other key indicators have improved: Equity markets have roared back, posting one of the best first-quarter improvements in the past century. This came after one of the worst fourth-quarter declines in a century, so it is fair to question how much more momentum equities may possess. Even so, the stock-market declines late last year were driving recession fears, so the resiliency of equities is significant. As it relates to the yield curve, it’s worth noting that historically, the stock market performs well from the time of an inversion to the next recession.
The Conference Board Leading Economic Index (which weighs unemployment, building permits, stock prices, consumer sentiment and other factors) has improved recently month over month, after declining steadily more recently. This too suggests that recession is not near.
The housing market, another key indicator, is improving after a very tough 2018. In December, we shared our view that the home-buying slump was due primarily to short-term sticker shock caused by rising interest rates, and that improvement was likely. With mortgage rates now falling, that is proving to be the case.
Last fall, a precipitous drop in oil prices was another reason for people to fear a looming recession. Our view was that energy demand remained strong and that falling prices were caused by an excess supply of crude. OPEC production cuts have addressed this, and oil prices have roared back, signaling confidence in demand.
The yield curve is an important economic indicator, and we continue to monitor it closely. Tiedemann portfolios are well diversified and positioned for a period of uncertainty.
But the fact remains, the recent inversion of the yield curve involving the three-month Treasury was brief and in any case, is only one of many data points that need to be considered when looking for recession flags. As we monitor the data closely, we continue to emphasize a diversified portfolio suitable for uncertain times.