As the yield curve flattens, investors continue to worry about the potential implications for the economy and markets. Why? Inverted yield curves have a perfect history of predicting economic recessions over the past 50 years.
The yield curve is a graphical representation of bond yields of similar credit quality across a range of maturities. A flattening curve, when shorter-term rates rise more quickly than longer-term rates (or fall more slowly), is often perceived as an indication that slower economic growth lies ahead. An inverted yield curve, where short-term rates are higher than long-term rates, has historically been a precursor to a recession.
Earlier this year, the difference between the 2- and 10-year Treasury yields was down to 0.50% before bouncing some, but it is currently back down to 0.54% (as of Thursday’s close). Does this mean trouble is around the corner? Looking back at the previous five recessions, once the yield curve hit 0.5% it took a median of nearly a year before the curve inverted. Once it inverted, it took about 20 more months until a recession started. All along the way, the S&P 500 posted a median return of 21.5% over those 32 months.
“A flattening (or inverted) yield curve can be concerning, but everyone makes it sound like that means a recession will start tomorrow. History says otherwise,” said Ryan Detrick, Senior Market Strategist. “Don’t forget we are looking at record profits and revenues for the S&P 500 in 2018 amid multi-decade highs in manufacturing and services, along with soft data indicators such as consumer confidence. In other words, the economy is still on quite firm footing, and we see few reasons to expect a recession over the next 12-18 months.”
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