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The inverted yield curve: what does this really indicate?
The news of an inverted yield curve has been lingering around market news headlines for days. For reference, an inverted yield curve occurs when long term rates are less than short term rates. It typically indicates that the chance of an economic recession in the future is high. With those headlines glooming over the average investor, it is important to know what the inverted U.S. yield curve represents, and what the warning signs indicate.
Consumer positive. With the difference between short term and long term CD rates narrowing, this is a positive for some consumers that choose to only keep their money out of reach for shorter periods of time. Rates dropping also means lower mortgage rates, that are favored by many consumers.
Not always a recession indicator. Not all yield curve inversions that have occurred have been followed by a recession, it may just be an irregularity. The Federal Reserve may also be a contributing factor to the inverted yield curve. The market may be reacting to the Fed keeping the short-term rates too high, pushing the Fed to make rate cuts, just as they did a few weeks back.
Inverted curve. Historically an inverted yield curve is viewed as a recession indicator for the economy. This is because short term rates are paying more than long term rates. Last week, The U.S. Treasury offered a two-year CD that paid more than a longer term CD, like the 10 year.
Stocks to bonds. The U.S. yield curve could have an inversion because investors are shifting from stocks to bonds. A loss of confidence in the economy pushes many investors to selling their stocks and putting that money into bonds, that are typically viewed as a safer investment. So as the demand for bonds rises, the yield drops.
It’s about how you react. The U.S. yield curve is a graphical representation that helps shape the current and future outlook of the economy. The inversion has gone away for right now, but it may invert again soon. Although an inverted yield curve typically precedes a recession or economic downturn, that isn’t always the case. Sometimes it is just an anomaly. However, as investors fear that a recession is soon to come, many pull their money out of the “riskier” stock market, and into the “safer” bond market.
https://www.reuters.com/article/us-usa-economy-yieldcurve/u-s-yield-curve-invert-steepen-repeat-idUSKCN1VA11G, Richard Leong August 20, 2019
https://www.cnbc.com/2019/08/14/the-inverted-yield-curve-explained-and-what-it-means-for-your-money.html, Al Lewis August 14, 2019