A dark omen from the bond market


The US economy is sound and unemployment is at historic lows. Yet trouble may be brewing on the horizon, thanks to the dreaded inverted yield curve that showed up on March 22.

Technical analysts are raising the alarm about a troubling shift in the yield curve, a plot line of short- and long-term interest rates.

That’s everything from three-month, two-year, five-year Treasury debt to the longer-term, 10-year bond.


Warning, Warning!

Think of the yield curve as an early warning system from the broader US economy.

As Bloomberg points out:


“The yield curve has historically reflected the market’s sense of the economy, particularly about inflation. Investors who think inflation will increase will demand higher yields to offset its effect. Because inflation usually comes from strong economic growth, a sharply upward-sloping yield curve generally means that investors have rosy expectations. An inverted yield curve, by contrast, has been a reliable indicator of impending economic slumps.




Crystal Ball

Here’s the thing about inverted yield curves: They have an incredible record of predicting recessions.

According to research from the San Francisco Fed, every recession of the past 60 years has been foreshadowed by an inverted yield curve.

There has only been one
false positive, back in the mid-1960s when an inversion was followed by a shallow slump that didn’t rise to the level of an official recession.


Takeaway

Nobody has a crystal ball, and it’s impossible to know for sure whether the US economy is heading for a downturn.

Yet the current business expansion is pretty long in the tooth and recessions are a fact of life.

In my view, that’s something to remember as you process the latest news and manage your portfolio in the months ahead.


Photo Credit: Zooey via Flickr Creative Commons

Author profile

Xavier Brenner
Xavier Brenner
Xavier Brenner has covered global market, business and economic trends for Interactive Brokers Asset Management since 2013. An experienced financial journalist, Brenner offers analysis and insights on the stories that matter to the discerning investor.