Oddly enough, the US has never been in a recession without an inverted yield curve, however; we have seen the yield curve invert and no recession follow. The slump in the fixed income and equity market through 2022 have been driven by two primary concerns, (1) inflation and (2) the Federal Reserve interest rate hikes. Both have been discussed by the financial news ad nauseum and used to spread fear to investors as they could foreshadow an ugly recession for the US economy.
Putting inflation aside, these same investors have had to find places to hide this year because of the selloff in markets. Sure, a lot of those market participants will take their cash and head to the sidelines while they wait for the environment to shape up before they buy back in. But on the other hand, many of them have decided to earn a few percentage points on their money by letting it sit in short term bonds for the time being. As of Dec. 2nd, investors can buy 3-month Treasury Bills and get paid 4.34%*, which is considered the most “risk-free” investment that one can make (since its backed by the US Govt). Considering stocks were down 25%, on average, at the tail end of September, this hasn’t been a bad strategy at all – and one to possibly consider going forward.
The issue with this is not so much for the buyer of the bonds, but it’s the message that the market is sending about the economy. Markets rely on the participants taking risks. When people stop taking risks, red flags go off; and that’s what is going on in the bond market. It is warning that we might see some ugly days ahead for the US economy. With the 2-Year treasury rate at 4.28% and the 10-Year rate at 3.51%, it is obvious that you are getting paid less to hold your bonds for a longer period.
*Reference the blue line as the current representation of the yield curve, and the grey for the historical*
That’s the opposite of how it should work, right? Well, this is the inverted curve and the red flag. Think about the housing market for a second. Do homeowners buy and sell their home on a weekly or monthly basis? No, they live there for several years and often sell it at a higher price. Historically, this type of bond environment coincides with a US recession, but as mentioned at the open, it is not always indicative of one.
My message here is that this should be seen as a cautionary warning to what is possibly coming. Investors should not panic over this. Instead, maybe take advantage of this and use the extra change sitting in your bank account to buy 1-month T-bills, which will pay you 3.91%. You will not find a bank that will pay you that amount of interest for a 1-month period; or a 1-year period for that matter.
Lastly, if the Federal Reserve is nearing the final stages of their rate hike cycle, and inflation will begin its decent to the 2% preferred level, then it’s possible we might have seen the peak in treasury rates. It’s not definitive, but personally, I have no problem getting paid nearly 4% on my cash while it does nothing for a month.
*All Treasury Rate figures represent current market values as of December 2nd, 2022
Disclosure: Michael Lafata is a Financial Advisor offering securities and advisory services through Cetera Advisor Networks LLC, member FINRA/SIPC, a broker/dealer, and a Registered Investment Adviser. Archstone Financial is not a subsidiary of nor controlled by Cetera.
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