The financial news media has been abuzz about the so-called “yield curve” for a while now, but a couple of factors this week have intensified the rhetoric. For those of you who are not familiar with the yield curve and its potential effects on the economy, I thought I’d fill you in on the highlights so you can see what the fuss is all about.
You can find a lot of complex definitions of “yield curve” online, but I like the way Matt Phillips of the New York Times put it. In “What’s the Yield Curve? ‘A Powerful Signal of Recessions’ Has Wall Street’s Attention,” Phillips described the yield curve as, “basically the difference between interest rates on short-term United States government bonds, say, two-year Treasury notes, and long-term government bonds, like 10-year Treasury notes.” Simple enough, but why is that difference important?
As Phillips notes, in a healthy economy, the yield curve is more of an actual curve, because long-term bond rates will be higher than short-term bond rates. But when the curve begins to flatten, and the gap narrows between rates for short- and long-term bonds, some believe that’s a signal that the economy could fall into a recession.
Long-term bond rates have not kept up as the Federal Reserve raised short-term interest rates twice this year. In fact, according to the Wall Street Journal, the gap between yields for short- and long-term bonds is at nearly an 11-year low. A release of minutes from last month’s Fed meeting showed the Board of Governors still supports the Central Bank’s plan to increase rates gradually. They also discussed the yield curve, and whether it is still an accurate bellwether of future economic activity. Some at the meeting pointed to other factors that could contribute to a flattening of the curve, while others felt it was still necessary to monitor, given the “historical regularity than an inverted yield curve has indicated an increased risk of recession in the United States.” (An inverted yield curve occurs when interest rates on short-term Treasuries exceed interest rates on longer-term Treasuries.) Research by the Federal Reserve Bank of San Francisco shows that an inverted yield curve has preceded every recession for the past 60 years.
With tariffs on Chinese imports now in effect, and China’s vow to retaliate now on the table, some investors believe the yield curve will flatten even more. They are also watching the June jobs report from the Department of Labor to see whether wage inflation might send long-term yields higher, making the curve steeper.
Should you be concerned? While some pundits are predicting a recession could happen in 2019 or 2020, other market observers don’t think so. Even Janet Yellen, the former Fed Chair, argued that the flattening yield curve had more to do with a change in the curve’s relationship with the business cycle.
Is there a chance for recession? Anything is possible. But these figures may help to put things in perspective: The New York Fed forecast the probability of a U.S. recession by June 2019 at around 12.5 percent. On the eve of the Great Recession, it was 40 percent.
If you have concerns about the yield curve, or whether your portfolio can weather a recession, please contact us. At AMDG Financial, we work with our clients to help them manage through all kinds of economic climates to achieve their goals. We’d be glad to give your portfolio a second look and discuss your needs. To schedule a series of complimentary appointments, simply click here and fill out the form. We’ll be in touch to answer your questions.