Executive Summary
According to the CME FedWatch Tool, the first Fed rate cut is expected on 18 Sep '24. This implies that the yield curve will still be negative by then; in conclusion, investors should keep their money in the S&P 500 and high-yield savings accounts ― 5% or higher.
Why Investors and Traders Should Care About the 10Y-3M Yield Curve!
The yield curve is a leading economic indicator that helps investors and traders predict the future of interest rates, economic activity, and potential investment returns on different asset classes. Normally, investors want to see a positive yield curve on government bonds ― longer maturity bonds yielding higher rates than shorter maturity bonds; long-term bonds should be riskier than short-term bonds to compensate for the risk of not knowing what the future holds. When the long-term bond yield is lower than short-term bonds investors become wary of the long-term economic outlook. By the end of this report, investors and traders should be able to make an informed investment decision based on the shape of the yield curve.
Key Points
The current Yield Curve is -1.04%. The Yield curve, using the 10-Year Note and 3-Month Treasury, has been negative since 25 Oct '22. It hit as low as -1.89% on 1 Jun '23, this implies that the probability of a recession in 1H ‘25 is greater than 75%. Furthermore, year-to-date and 12 months ago, the yield curve was negative, -1.51 and -1.69, respectively. Using data from the late 1980s, early and mid-2000s, and late 2010s, the average time for the inverted yield curve has been seven months followed by an average recession of ten months which usually took place no more than six months after the inverted yield curve turned positive.
The Longer the Yield Curve Inversion the Longer the Recession
The 10Y-3M yield curve inverted on 25 Oct '22, which was 19 months ago; during the time, it hit its lowest level ever on record since 1980 — -1.89%. Fortunately, larger negative yields do not mean longer recessions; the time of the yield curve matters the most. The length of time of the negative yield causes a bigger impact on the economy once it turns positive. Inverted yield curves signal weaker short-term economic conditions ― higher inflation or unemployment rates. For the past 18 months, investors have been moving away from long-term into shorter-term bonds; inflation was one of the main factors of such an event, causing the Fed to start hiking interest rates in Q2 '22. At 3.4%, Inflation has slowed down, but the Fed is still keeping rates higher because inflation is above the 2% Fed target.
Investment Analysis
The first Fed rate cut will send a dovish signal to the bond and stock market implying a greater economic growth ahead; unfortunately, it will also trigger the yield curve normalization. Once the Yield curve turns positive it will take no more than six months for the economy to enter into a recession. Since the yield curve is still negative investors should stay away from bonds with maturities longer than five years and stay invested in the S&P 500; also, take advantage of the 5% plus high-yield savings accounts if you find bonds too boring.
Comments