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Saturday, July 31, 2021

The ‘Inverted Yield Curb’ Explained

Traders and investors have been asking what is the “inverted yield curve”, this unusual bond market phenom came on briefly last week for the 1st time in over 12 years and shook Wall Street with talk that an economic downturn was imminent.

Following a tweet from President Trump referencing the “CRAZY INVERTED YIELD CURVE!”, the term made its way onto news websites and radio and television reports that rarely delve into financial topics.

Even a late-night TV host devoted a portion of his show trying to decipher what it means when the yield on 10-yr US Treasury falls below those for 2-yr notes.

The abnormal bond market dynamic has preceded US recessions by 18-22 months in the past, and when it appeared last Wednesday for the 1st time since Y 2007, it shook investors concerned that a US-China trade dispute might kill both a record-long economic expansion and this 10 yr Bull market for stocks.

Bond yields are a Key measure of the return the securities deliver to investors, and they are also a proxy for interest rates.

When the yields on bonds of different maturities are plotted on a graph, it produces a curve that typically has an upward slope because investors expect greater compensation for the risk of owning longer-maturity debt. An inversion, when shorter-dated yields are higher than longer-dated ones, implies that investors see greater risks in the near future.

Reuters Graphic

The US yield curve has been slowly flattening since Y 2013ish, and while economists and central bank policy makers have hotly debated its significance, the trend has mostly gone unnoticed by the public.

The spread between 2-yr and 10-yr T-Note yields has slipped below Zero before each of the last five U.S. recessions, although it has taken anywhere from 18-22 months for the recession to happen. The curve’s inversion often ended before a recession began, and the inversions did not predict the length or severity of an economic downturn.

Notably, the yield curve has returned to its normal since last Wednesday’s brief inversion.

Analysts, economists and investors are watching to see if the yield curve reverts again and enters an inverted trend, which would increase concerns across Wall Street and put more pressure on the Fed to cut interest rates to bolster the economy.

We get some further insight in to the Fed’s take on this phenom from Fed Chairman Friday from Jackson Hole.

Stay tuned…

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