Monday, April 23, 2018

How Do Stocks Typically React When the Yield Curve Inverts?

  • The 10 Year Treasury yield is currently pushing upward testing the 3% level, a mark that it has not breached on a month end close basis since July 2011.
  • Over the past year the Treasury yield curve 10 / 2 spread has contracted from 105 basis points to as low as 41 in the past week, raising market fear that it will turn negative in the coming year.
  •  An inverted yield curve is historically a sign of trouble ahead for stocks and the economy, but the actual impact on stocks is different in a rising rate inflationary environment versus a falling rate, deflationary market.

Short term interest rates have been rising much faster than long term interest rates over the last year.  Many investors use the tightening of the yield curve, and in particular 10 Year and the 2 Year Treasury spread as a recurrent signal that future economic activity is likely to slow down and the day of reckoning is near for stocks is near.   Over the past year the 10 / 2 spread has contracted from 105 to as low as 41 basis points.   The yield curve over the past several days has rebounded back to 50 basis points, with a sudden increase in the 10 Year toward the 3% level being the underlying driver to the spread widening.