What Does an Inverted Yield Curve Mean? Part Deux

Last week, we took a closer look at the yield curve to show why an inverted yield curve didn’t necessarily mean a recession was right around the corner and why years of economic growth and stock market gains were still possible. Today we’ll take a different look.

First, you may wonder why the yield curve is in the news so much and why we are writing about it again. Well, according to the San Francisco Federal Reserve, which defined the yield curve as the difference between the yields on 10-year and 1-year Treasury securities, a negative yield curve preceded the last nine U.S. economic recessions.

Another commonly referenced measure of the shape of the yield curve looks at the difference between 10- and 2-year Treasury yields, which has also continued to flatten and last week was at its flattest level since ahead of the financial crisis more than 10 years ago. Of course, neither measure has inverted yet, but there have been periods with a relatively flat yield curve that have lasted years before a recession (the mid-to-late 1990s for instance). As we lay out in our recently released Midyear Outlook 2018: The Plot Thickens publication, we remain positive on the economy thanks to the benefits of fiscal policy, government spending, and financial deregulation. For these reasons, we do not anticipate a recession over the next 12-18 months.

But what happens when the yield curve finally inverts? As our LPL Chart of the Day shows, equities can continue moving higher even after the yield curve inverts. LPL Research Senior Market Strategist Ryan Detrick added, “Contrary to what many people think, inverted yield curves don’t always sound the alarm to sell. In fact, looking at the past five recessions, the S&P 500 didn’t peak for more than 19 months on average after the yield curve inverted, along the way adding more than 22% on average at the peak.”

For more of our thoughts on the yield curve and what we think stocks, bonds, and the economy will do the rest of 2018, please be sure to read our Midyear Outlook 2018: The Plot Thickens publication.

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