The financial media returned to a favorite topic in the last week, yield curve inversion, but we caution against getting caught up in the building frenzy.
The Treasury yield curve inverts when short-term interest rates move above long-term rates. As shown in the LPL Research Chart of the Day, the 3-month Treasury yield has sporadically moved higher than the 10-year over the last several weeks. Since the end of World War II, some type of inversion has preceded every recession, although often well in advance and shallow or brief inversions, such as we saw in 2019, can be a false signal.
“The yield curve is an important economic signal,” said LPL Chief Investment Strategist John Lynch, “but foreign demand for U.S. Treasuries and Fed bond purchases to stabilize repo rates are having an impact on the shape of the curve. We would need to see a much more decisive signal to be concerned.”
Based on our research, inversion needs to be pronounced to be meaningful. We would also typically need to see inversion associated with the Federal Reserve trying to pump the brakes on an overheating economy or being unresponsive to an economy that is significantly slowing. Neither appear to be in play now. Historically, the 3-month Treasury yield needs to sit at least 0.5% above the 10-year before becoming a potential red flag for recession, a signal that is still a ways off.
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