YieldMarch 27, 2019 -
Categorized in: IAG News
One very important market indicator has plunged 25% since November 8, 2018, and has not bounced back with the stock market. Can you name it?
Here is a hint: Agent 007 encounters this indicator at a low-traffic intersection in Washington, D.C. that he travels through only once per decade.
If you guessed the yield on 10-year U.S. Treasury bonds you are a winner. If you didn’t, I would blame my horribly confusing hint.
On November 8 you could have earned 3.24% of interest annually on a 10-year U.S. Treasury bond. As of March 25 you would now earn 2.43% on the same bond.
This plunge has fanned the potentially self-fulfilling rumors of a future recession. While recent economic reports have shown a slow-down in economic growth, few are showing any signs of a recession in the next few months.
Yet recession concerns are rising because it is unusual for the yield on 10-year U.S. Treasury bonds to be lower than the yield on a 6-month U.S. Treasury bills. If you go to your bank today and they are offering you a choice between a 5-year CD at 2.20% and a 6-month CD at 2.50% you would think something is amiss.
This “yield curve inversion” – where short-term yields are higher than long-term yields – has preceded most recessions since the 1950s by 12 to 24 months. Yield curve inversions have also given false signals where no recession occurred in 12 to 24 months. We cannot know today if this signal is true or false.
Yield curve inversions occur because two different forces control short-term and long-term interest rates. The Federal Reserve controls short-term interest rates by setting its overnight lending rate. Right now their target overnight rate is 2.25% to 2.50% which essentially serves as a floor and ceiling for short-term bond yields. The Federal Reserve is currently cautiously optimistic about future economic growth, though they are puzzled by the lack of inflation.
Global bond traders control long-term interest rates by setting the prices at which longer-term bonds trade. Higher prices result in lower yields and lower prices result in higher yields. Right now global bond traders view the risk of higher future interest rates and inflation as being very low, so they are bidding up bonds (causing the yield to plunge).
A yield curve inversion tells us at least one of these two forces is wrong. If the Federal Reserve is correct, this inversion will be a false recession signal. If the global bond traders are correct, this inversion will be a true signal and we would likely see a recession in 12 to 24 months.
While discussing economics and bond trading could add a feeling of uncertainty to your future, know that your long-term financial plan and your IAG investment portfolio are personally designed to help you move forward toward your goals despite which market force is currently in control.
Quote of the week: Donald Rumsfeld: “I would not say that the future is necessarily less predictable than the past. I think the past was not predictable when it started.”
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