According to Business Insider, the inverted yield curve represents one of the main indicators of a recession, but not the only one to keep an eye on.
The previous inversions preceded a recession by two years, making it difficult to use them as an accurate indicator. During those 2 years, stocks in some cases showed good results. A de-inversion, or a re-steepening of the yield curve, typically precedes an imminent recession.
Investors usually point to the inverted yield curve as a reliable signal that the economy is about to face a recession. Since 1960, every time the US 10-year and 2-year Treasury bond yield curve inverted, with short-term bonds yielding more than long-term ones, a recession followed.
There is another signal investors should pay attention to that historically signaled a recession is coming. This signal is when the yield curve changes, or when short-term and long-term bonds return to a higher yield for longer maturities. Commonwealth IT director Brad McMillan says, “when the yield curve doesn’t invert, that signals a recession coming (within one year based on the last 3 recessions), while inversion signals problems coming in the medium term, within one year”.
Since the yield curve turned negative in July of last year due to the sharp interest rate hike by the US Federal Reserve, it did not invert until last week. On March 7, the 10-year and 2-year Treasury bond yield curve inverted over 1%, which was the sharpest turn since the 1980s. However, the consequences of the Silicon Valley Bank crash led to a sharp drop in interest rates and the fastest 3-day change in the yield curve since 1982.
The yield curve has more than halved inversion to negative 42 basis points this week, and if the US Federal Reserve puts the interest rate hikes on hold and short-term yields continue to fall, full un-inversion of the yield curve will be inevitable and will signal that a recession is already imminent.
“The yield curve always cruelly inverts to recession,” says Michael Hartnett of Bank of America.
However, Peter Essele, Head of Portfolio Management at Commonwealth Financial Network, believes that although the signal is worrying, it’s not time to sell stocks yet. Economic cycles in the later stages often bring stable returns for investors. The forward-looking yield only becomes a problem after the yield curve is fully inverted. So, it’s too early to sell risky assets.