The Yield Curve Inverted – What Should I Do?
By Chris Hostetler
A commonly cited indicator of recessions may have presented itself recently.
This needs a bit of a technical description before we get into the practical stuff: We’re looking at the yield curve, which measures how much you expect to get paid for U.S. Treasury bonds of various-length maturities. This curve was briefly inverted recently (Friday 3/22 through Thursday 3/28). On March 28th, you could have bought a Treasury bill maturing three months later and receive a 2.43% yield. But if you had bought a Treasury bond maturing 10 years later, your yield would be only 2.39% (annualized).*
That’s right, you’d get paid more for buying a short-term Treasury than a long-term. If that sounds weird, it should. Investors typically demand a higher yield for longer-term investments.
You may already be bored, but bear with us – this is important. It matters because an inverted yield curve has a high correlation as a leading indicator for recessions.
So far, the inversion lasted for only a few days; it could be just a blip, relatively meaningless. In fact, 10-year Treasuries have begun offering a higher yield already this week on optimism over a possible trade deal between the US and China.
But if this inversion were to last for several months, it could be signaling that a recession is looming. The simplified argument is that the inversion of the yield curve implies that so-called “smart investors” are putting their money in safe long-term investments as a haven until the storm passes. As more money piles into the 10-year Treasury, its yield drops.
Regardless of what the yield curve does, it appears likely that economic growth in 2019 will be slower than it was in 2018, in the US and globally. It is even possible, though less likely, that we enter a recession this year.
“Should I panic?” you say. Our answer is almost always no.
“But what if the yield curve remains inverted for several months?” Still no – panic is counterproductive.
However, there are some smart steps you can take. These are the same recommendations we would make during normal markets; we just might advise you a little more adamantly if we believe a recession might be around the corner.
Know how much cash you need over the short term, say the next two years. Work with your financial advisor to make sure you are prepared to meet your needs without having to take money out of your portfolio.
Review your investment risk tolerance with your advisor. We usually advise against changing your risk level because of temporal market conditions (short-term performance is impossible to predict consistently). But it’s always wise to review how much volatility you’re prepared to handle.
Avoid trying to time the market. This is a corollary to Step 2. Market performance is impossible to predict, especially in the short-term (yes, we know we already said that). By moving all of your investments into cash or Treasuries, you risk losing ground if the market should surprise to the upside.
Be thoughtful about the timing of any big sales or purchases you might plan on making over the next few years, such as a home or business. If we enter a recession, your strategy might change; you should have contingency plans for good markets and bad markets.
To be clear, we are not predicting that a recession is right around the corner. There is no single indicator that works as a foolproof forecaster, even the inverted yield curve. It is still easy for us to build a hypothetical scenario where the markets to see strong growth over the next few years.
Financial planners and money managers should study the economy and markets with a humble awareness of the unpredictability of such things.
But it is important to be aware of the signs the market is giving you. Even while building for the future, you should prepare for the possibility of a weak economy, now and always.
*Daily Treasury Yield Curve Rates: https://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/textview.aspx?data=yield