After months of flattening, another yield curve has actually inverted. Last Friday, in the wake of weak economic data in the Eurozone, a global bond rally drove down yields. The 10-year Treasury note yield fell as low as 2.42%, which was below the three-month T-bill yield at 2.455%.
There has been considerable discussion in the financial community about this event because a yield curve inversion has accurately predicted the past nine recessions. An inverted yield curve doesn't actually cause a recession, it's just a distillation of the market's crowd wisdom.
Before succumbing to the media headlines that warn of an imminent bear market or recession, it's worth remembering a few things. First, while an inversion has a strong record of predicting recessions, they tend to come with long and variable lags. During the last cycle, the spread first fell below zero in January 2006, almost two full years before the start of the recession. And during those lag times, equities have historically put up respectable performance numbers.
Second, the catalyst for the inversion was, in part, the about-face we witnessed after the FOMC meeting last week. Policymakers lowered their gross domestic product (GDP) growth projections to 2.1% for 2019 and 1.9% for 2020. Their projections painted a strikingly different picture of the US economy and future policy than what they shared just three months ago. That was a tough pill to swallow for fixed income investors, especially in an expansion that is ten years old.
Finally, there is still evidence that solid US fundamentals are intact even as the global economy struggles with intensifying trade and political risks.
The Conference Board Leading Economic Index® (LEI) increased 0.2% in February to 111.5. This was the first increase in five months and was driven by accommodative financial conditions and a rebound in stock prices.
At his news conference last week, Fed Chairman, Jerome Powell said the economy “is in a good place” and "economical fundamentals are still very strong” adding that Fed officials "see a favorable outlook for this year."
So while the bond market is flashing yellow caution signs, exiting the market all together would be an overreaction. Rather, use this moment to examine your portfolio; rebalance your asset mix back to targets and talk with us if your tolerance for risk has changed. While we don't believe a recession is imminent, once we get there (and we will), we want you to be prepared to weather the downturn.
