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July 13, 2018  
 Investors are freaking out about this.
Should you? 


The thing they're freaking out about is the flattening "Yield Curve". Articles about it are popping up all over the place and the overwhelming majority of those articles paint a pretty dire picture for the economy. Should you be concerned?
 
You should be concerned enough to make sure you understand what it is. Here's a quick summary:
 
You have a Government issued 2-year Treasury bond and a 10-year Treasury bond. They both pay interest. Typically, the 10-year pays a higher interest rate than the 2-year to compensate buyers for the time difference; 8 years longer in this case.
 
The difference between the interest rates these two bonds, the 2-year and the 10-year, is called the "spread". If the spread is greater than zero, it means the 2-year interest rate is lower than the 10-year, as is normally the case. In other words, if you put the "spread" on a chart, the 2-year interest rate will be a dot in the lower left corner and the 10-year interest rate will be a dot in the upper right corner, thereby giving the appearance of a rising chart, hence, an upward sloping yield curve.
 
When the "spread" is negative, the yield curve "inverts", giving the appearance of a negative yield curve.
 
 
 
The logical question is "how exactly is a negative yield curve on a chart connected to a possible recession"?
 
Answer: It is fundamental to how banks make money. Banks borrow short term, at lower interest rates, so that they can make long term loans to borrowers at high interest rates. The difference between those two interest rates, the positive "spread", is their profit.
 
But if a bank is borrowing short term, this time at a high interest rate, and making loans to borrowers at a low interest rate, the difference is a negative "spread". Meaning, banks would lose money by making loans. Not necessarily on all loans, but it does make some loans unfeasible and some less profitable, forcing banks to cut back on making loans; thereby choking off credit/loans that businesses need to grow.
 
When it becomes harder for businesses to borrow, many businesses cancel or delay projects and hiring. Weaker businesses go out of business because they lose access to credit, which in turn causes layoffs. When this happens, it takes about a year, on average, for the U.S. economy to slip into a recession.
 
The last 7 out of 7 times the yield curve went negative, since the 1960's, a recession followed. Don't stop reading just yet!
 
A lot of commentators believe that a flattening or negative yield curve is currently not relevant in a world of massive central bank intervention, encouraging foreign investors to scoop up long term U.S. Treasury's because their home-country government bond yields are much lower. To believe this, that "it's different this time", means that you'd have to believe that the math in the above example stopped working. But last I checked, banks still borrow at short term rates and lend at long term rates, as long as it is profitable. 
 
Right now, the yield curve is just about flat, with a slightly positive slope and a spread of just 0.25%. What could stop the collision course between short and long term interest rates? Two things; the Federal Reserve could stop raising short term rates or investors could lose their appetite for holding onto their existing supply of Treasury's. Neither of those two things seem likely at the moment.   
 
Last November, when the yield spread was 0.80%, I wrote a brief warning article all about this. There are a few details in it that I didn't include in the above. If you read it, you'll be the coolest economist at every cocktail party you attend this weekend. I send you there now:
 
 
If you're looking for a better way to save, invest, and plan for your retirement, click on the "Let's Talk" picture below to schedule a 15 minute phone call with me.

 
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Thank you for taking the time to read this!
Mitch
 
 
I opened ClientFirst Strategy, Inc. because I believe that the only way to help my clients potentially achieve their goals is by offering unbiased advice & investment management expertise. To my clients, thank you for your continued vote of confidence. If you are not a client but would like to explore the possibility of becoming one, I invite you to call me directly, visit my website, join my email list, and/or connect with me on social media.      

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All the views expressed in this report/commentary accurately reflect our personal views about any and all of the subject securities or issuers and no part of our compensation was, is, or will be, directly or indirectly related to the specific recommendations or views we have expressed in this report. This material is not intended as an offer or solicitation for the purchase of sale of any security or other financial instrument. Securities, financial instruments, or strategies mentioned herein may not be suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. Prices, values, or income from securities or investments mentioned in this report may fall against your interests, and you may get back less than the amount you invested. The information contained in this report does not constitute advice on the tax consequences of making any particular investment decision. You should consult with your tax adviser regarding your specific situation. Diversification is a method of managing risk and doesn't protect against loss in a down market. 
  
  

Mitchell O. Goldberg, AAMS, President | Investment Professional

OSJ Manager 

 

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