Market data:

Inverted Yield Curve

Today the market is throwing a new tantrum following the much-feared inversion of the yield curve. Technically speaking this is a a situation when the yield of the 2 year US Treasury is higher than the yield of the 10 year US Treasury.

In a normal environment, investors should expect to be rewarded more for longer holding periods but there are a few instances when the curve can invert. Usually, this occurs as the Fed raises rates on the short end rather quickly trying to prevent the economy from cooling off and produce inflationary pressures.  The markets, which controls the long end of the curve, may perceive the Fed’s action as too hasty and may start to price in recessionary fears on the 10-year Treasury in the form of lower yields, hence the inversion.  In today's case, the Fed has started to lower rates but the recessionary fears instigated by the trade war are overwhelming longer dated bonds.

It is a widely followed indicator because all seven of the last recessions were preceded by the yield curve inversion; however, not every inversion has actually resulted in a recession.  Another interesting element is the timing of the possible recession. On average, the 2/10 curve inversion has been followed by a recession about 15 months later.  We probably need to see some deterioration in the labor market before we can draw conclusions.

In terms of the S&P500 performance after the inversion, Dow Jones Market Data has provided the following table:

 

Date of first 2/10-year inversion 3 months later 6 months later 1 year 2 years

3 years

8/17/1978 -10.14% -6.10% 3.06% 19.64% 24.88%
8/20/1980 13.44% 2.27% 5.59% -8.69% 32.49%
12/9/1988 6.10% 17.93% 25.87% 18.31% 36.54%
5/26/1998 -0.90% 8.49% 19.26% 25.96% 16.81%
12/30/2005 4.16% 1.76% 13.62% 18.44% -28.65%
Average 2.53% 4.87% 13.48% 14.73% 16.41%