Inversion Invasion!

Why does an inverse yield curve matter?  How good is it as a predictor of future bad economic times?

An inverse yield curve means that interest rate yields for long term bonds are less than the yields for short term bonds.

You need to know two things…

1. Usually, long term bonds pay more interest, because they require that the bond-holders tie their money up for a longer period of time.

2. Bonds are bought and sold. The more that bonds are in demand, the higher the price for those investments, and the lower the corresponding yield.

So when yields on long term bonds are lower than yields on short term bonds, this means that some investors are buying enough of those long term assets to drive yields down to a point where they are actually below the yields on short term assets. This happens as a result of a “flight to safety”. Long term bonds - and we are talking about government bonds here – are generally considered to be safe assets. Although they provide little return to investors, they do serve to conserve wealth in difficult times, as they historically hold their value and even pay small rates of interest to investors when the stock market and the prices of other assets, like houses, tumble.

So an inverted yield curve means that some investors are taking cash out of more risky investments like the stock market, and they are parking their money somewhere that is generally considered to be very safe. 

Do you see a pattern to my recent blogs? In this uncertain and chaotic time, don’t stand pat...stay nimble and try to follow the "smart money"!

How good is this indicator?

Inverted yield curves are considered to be almost 100% predictive of recessions. On average, a recession follows about 9 months after the yield curve first inverts. 

This makes sense, as an inverted yield curve is actually saying that the “smart money” thinks we are at the end of an economic growth cycle and the economy is about to turn sour, otherwise they would not be seeking safer investments for their money.

The yield curve in the United States first inverted last Spring, and has done so twice since.

I’m just saying….

Caveat!  Virtually every single time that the yield curve inverts, a veritable army of professional talking heads takes to the airwaves and to the Internet proclaiming the reasons why it does not matter this time! History says something completely different.  

Do your own due diligence!