Even as the economy continues to demonstrate strength with a fully employed workforce and robust corporate earnings, some investors have been playing it safe by shifting assets into bondsA financial instrument representing an IOU from the borrower to the lender. Bond issuers promise to pay bond holders a given amount of interest for a pre-determined amount of time until the loan is repaid in full (otherwise known as the maturity date). Bonds can have a fixed or floating interest rate. Fixed-rate bonds pay out a pre-determined amount of interest each year, while floating-rate bonds can pay higher or lower interest each year depending on prevailing market interest rates.. U.S. Treasurys, the go-to in times of uncertainty, have benefited the most and as prices have risen, yieldsYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. have fallen. The benchmark 10-year Treasury’s yieldYield is a measure of the income on an investment in relation to the price. There are several ways to measure yield. The current yield of a security is the income over the past year (either dividends or coupon payments) divided by the current price. has again dropped below the 3-month Treasury bill’s yield—a so-called “inverted yield curve” where shorter-maturity bonds sport higher yields than their longer-maturity counterparts. With the 3-month Treasury out-yielding the 10-year by 0.11% this week, the steepest inversion since 2007, you may have heard one of the many pundits rushing to proclaim a recession is on the horizon.
The inverted yield curve does have predictive qualities, having preceded the last seven recessions, so it should not be easily dismissed. However, the inverted yield curve is not a Swiss watch you can set your recession timing to. On average, there has been a lag of more than 12 months between the yield curve’s inversion and the start of a recession—and even then, we often don’t know that a recession has started for several more months.
Keep in mind that while predicting the last seven recessions sounds impressive, it is a very small sample size. Additionally, an inverted yield curve doesn’t tell us the length or severity of the next recession, nor how the stockA financial instrument giving the holder a proportion of the ownership and earnings of a company. market will perform before or during it.
We are keeping a close watch on the yield curve. But we view it as one factor among many that we consider when it comes to evaluating the state of the economy, the stock and bond markets and the composition of our clients’ investment portfolios.
Please note: This update was prepared on Friday, May 31, 2019, prior to the market’s close.
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