Is The Yield Curve Really Inverted?

So did the Yield Curve invert or not? We kept hearing it did last week. Every time we looked at closing prices, it wasn't inverted. What's going on?

We think we finally found out.

Every month we check our various stats and ratios the may or may not have changed since last month. Mostly things don't change much. Sometimes they do.

Before the stock market took a blow to the chin beginning in January, there were some divergences between some indices that signaled at least yellow if not red. When prices began dropping, it came as no surprise. (Of course, no one should have been surprised given how long the Bull Market since 2009 has lasted, and how overvalued the stock market was by any reasonable measures.)

Now we've got a bounce in stocks. Is it a bounce in a Bear market? We think so.

Along with stock stats, we look at bonds, typically yields along the so-called Yield Curve. At the moment, the most important relationship many of us think is that of the 2-year and the 10-year treasury. The 3-month and the 10-year was once a biggie, but since 2009 the Fed has completely suppressed short rates, so that relationship became less interesting. In a freer market, that short rate would likely have risen more, but it kept getting smacked down, so we had to consider that suppression and actual perversion of the Yield Curve.

Anyway, back to the 2-year/10-year: That's the one to watch now since the Fed has less ability to sit on the 2-year than it does on the 3-month. So those yields move more freely. They're less perverted. 

So all week the financial media shouted: the 2-year jumped above the 10-year. The Yield Curve is inverted! But every time we checked in to the closing prices posted on the Treasury's website, we didn't see this. The 2-year remained below. And so our month-end report, even in the face of the screaming headlines, did not indicate an Inverted Yield Curve - again, based on closing prices. (We do give more weight to closing prices rather than intra-day prices.) However, we did notice that the 2-year was steadily catching up to the 10-year. So it's likely that intra-day it surpassed the 10-year a few times then flopped back at the close.

But today we checked the April 1st closing prices and, lo and behold, the 2-year was above the 10-year. And that makes the Yield Curve "inverted."

It's inverted because in a relatively "healthy" economy yields "should" rise from lowest term to highest, i.e., from 1-month treasuries to 30-year treasuries. The spread can be tighter or wider, but if they rise one to the next, there's no inversion. Inversion occurs when one or more of the shorter terms yields rise above one or more of the later term yields. And that's what happened.

At this point, we could wait to see if it sticks. Anomalies do occur at times when you watch these stats. For example, another series we look at is the futures in the Gold market. Typically the nearer futures prices will be lower than the later. So, for example, the April futures will be lower than, let's say, the August futures. That relationship is known as "contango." But sometimes the futures will be in what's called "backwardation" - when the nearest months prices are higher than the later months. When that happens, it's supposed to signal that there's some sort of squeeze on gold in the marketplace and the price will likely jump. But sometimes you get one or two months in backwardation. Then they pop back to normal - contango. So you don't jump the gun when you see these anomalies. You wait until backwardation really flexes its muscles and gets set to yank the gold price higher.

And so we could consider this one-day inversion in the yield curve - again based on closing prices - as possibly an anomaly. But I suspect it'll stick. When you look at the trend of the yields, you see that the catching up and now surpassing of the 2-year over the 10-year has been brewing for a while. The distance between the two has narrowed and recently that narrowing accelerated. 

As you may know, an Inverted Yield Curve frequently (most of the time) signals that a recession is coming. It could be awhile before a recession fully manifests itself, but it's coming. 

Of course, recessions come in many flavors. Some are mild. Some, like the so-called "Great Recession" from late 2007 to early 2009 wipe out wealth like there's no tomorrow.

The Inverted Yield Curve doesn't tell us which flavor we'll get this time around. Could it be "Recession-Light" or "Recession-Almost-Depression"? Who knows for sure? But we can guess. And it wouldn't be too crazy to think a coming Recession will lean away from the light side - to put it mildly.

Now, those of us who get into the weeds on all this have and will continue to read how recessions don't pop right up when the Yield Curve inverts. The past tells us it's likely to take somewhere between 6-18 months to really get into a recession. And before that happens, stocks can go up - a lot, maybe even hitting new highs. That's all true. And if you want to "play" this inverted yield curve, go for it. Just remember that the typical pattern of those sucked into any market "melt-up" before a recession hits never actually get out before they get their gains and their guts sucked out them when the recession and/or a stock market crash jump them from behind.

Whether you're going to start getting cautious, or go for the gold (meaning stocks, not actual gold - a whole other story), good luck either way.