The recent flattening of the yield curve (specifically the 10-2 Year Treasury Yield Spread) has yet again garnered much attention from the media and market participants alike as many believe this signals an impending recession. The last inversion took place in 2019 prior to the beginning of the pandemic, merely a coincidence as the short Covid recession was driven by the virus and a purposeful economic shutdown.
The current flattening or inversion should be viewed in a wider context. Generally, this spread (graphically depicted by the green line) has had a relatively strong relationship to the 2-year-3 Month treasury spread (black line). However, these two are now moving in opposite directions. This implies that the short-end of the yield curve is very steep by historical standards while the intermediate-to-long end is flat.
This steep short end reflects expectations of aggressive policy response from the Fed to combat inflation. While valid, the consensus remains that inflation will moderate throughout the year as transitory factors abate (as the more substantial and relevant factor in long-term inflation trends is the increased money supply). This leaves the possibility of the Fed moderating their aggressive stance and the curve eventually pricing in fewer hikes.
As such, the current curve dynamic does not necessarily forecast a recession. It is more likely the market signaling that an overly aggressive Fed could smother an already soft economic growth trajectory more than anticipated. The Fed will be watching closely to incorporate market reaction into their future actions.
Lastly, while every recession over the past 70 years has been preceded by an inverted yield curve, not every inversion has preceded a recession. Where recession has occurred, an average of 20 months has separated the inversion and recession, with equity markets delivering generally positive returns during those intervening time periods.
At BerganKDV, our Wealth Management solution works alongside Investment Management professionals to ensure our client’s financial strategy is robust and diversified to address the uncertainties of the market. If you have any questions around the recent yield curve inversion, one of our advisors would be happy to assist you. Let’s have a conversation.
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