Many experts say that when the two-year Treasury yield exceeds the 10-year yield, recession is coming.
A lot of the talk about an inverted yield curve centers on the indication of recession. Many economists say an inverted yield curve signals an economic downturn is coming.
So what is it?
An inverted yield curve occurs when short-term Treasury yields exceed long-term yields. In recent days two-year yields have often topped 10-year yields.
But not all the implications of an inverted yield curve are negative. It usually signals that a stock rally is coming, Citigroup strategists write in a report cited by Bloomberg.
Stocks tend to gain in the 365 days that follow the beginning of the two-year/10-year inversion, the Citi analysts say. But the climb isn’t steep.
“Investors should expect sub-par but slightly positive returns from equities if inversion stays mild,” the strategists said. “Eventually U.S. equities turn down in year three, but still outperform international markets. Bonds do well for longer.”
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Stocks See an Uptrend
Ryan Detrick, chief market strategist at LPL Financial, also cited an uptrend for stocks.
“Looking at the previous four times the 2/10 year yield curve inverted shows the S&P 500 rallied for another 17 months and gained 28.8% until the ultimate peak,” he wrote on Twitter. “Beware some of the narratives taking place right now.”
As for an inverted yield curve possibly indicating recession, not everyone believes the most important relationship is between the two-year yield and the 10-year yield.
No Need For Fear
Federal Reserve researchers Eric Engstrom and Steven Sharpe say it’s the current three-month Treasury-bill yield versus investor expectations for where the three-month rate will stand 18 months from now.
“There is no need to fear the 2-10 spread, or any other spread measure for that matter,” Engstrom and Sharpe write.
“At best, the predictive power of term spreads is a case of reverse causality. That is, term spreads predict recessions because they impound pessimistic — often accurately pessimistic — expectations that market participants have already formed about the economy.”
A soft landing would mean reducing inflation without causing a recession.
Even if a recession is coming, yield-curve inversion doesn’t mean it will happen quickly.
The time gap between inversion and recession is usually of 12 to 24 months, Art Hogan, chief market strategist at National Securities, told Reuters.
“It’s really not something that is actionable for the average folks,” he said.
