Bond markets in the U.S. and abroad have for weeks been flashing warning signs of pending economic strife. And on Wednesday morning, they sent their clearest signal yet that trouble may be on the horizon, as the yield curves in the U.S. and U.K. inverted, each for the first time in more than a decade.
The yield curve is essentially a graph plotting out returns on government-issued debt. Under normal economic conditions, the curve will start flat and gradually slope upwards, with the idea being that investors will receive greater returns for holding investments that take longer to mature.
There’s typically more risk associated with holding a 10-year Treasury note, for example, than with holding a 2-year note, since it’s much harder to predict where the economy will be in 10 years than in two.
But that curve can invert, a scenario that implies investors are taking on more risk in the near term. Yield inversions aren’t considered to be sure signs of impending doom, but economists nonetheless see them as a particularly bad omen for what lies ahead over the course of the next year or two – especially in the U.S., where inversions have preceded every domestic recession dating back to the mid-1950s.
Over the course of more than six decades, the U.S. has only seen one false-positive yield inversion that didn’t foretell an impending recession. The U.S. 2-year/10-year yield hasn’t inverted since just before the Great Recession in 2007, while the U.K.’s yield curve hasn’t inverted since 2008, when the world was embroiled in a global financial crisis.
Although international economic growth has slowed this year – and ongoing trade friction between the U.S., China and other international partners hasn’t helped stabilize the situation – analysts aren’t uniformly running for their bunkers. Domestic labor market data continues to impress, and stocks soared Tuesday on the news that President Donald Trump decided to postpone and revise a series of tariffs on $300 billion of Chinese goods.
Some analysts believe international central banks’ continuously accommodative monetary policies have influenced the yield inversions, with interest rates in Japan and Europe diving into negative territory in recent years.
“After quantitative easing, we’ve screwed up the pricing mechanism all over the place, and nobody can really find true value anymore because of what the central banks have done to these markets,” Scott Shellady, managing partner at the Cow Guy Group, said during an interview Tuesday on “Bloomberg Markets.” “Going forward, we have an inverted yield curve because everyone else has negative rates. That doesn’t mean we’re going into a recession.”