Is this the First Domino?
Aug 23, 2019 | Frank Sakellariou
For the past year or so, business news headlines have been flooded with the news of the Yield Curve Inversion. Fears of a potential yield curve inversion have contributed to increased levels of volatility in the financial markets. Many argue that this event is the first domino to fall in a sequence of events that ultimately ends with an economic recession.
The Yield curve is a graphical representation of the differences in the yields of bonds with different maturities. The chart essentially plots bond yields vs bond maturities. A normal yield curve is positive sloping, meaning longer-dated maturity bonds have higher yields than shorter-dated bonds to account for maturity risk.
An Inverted Yield Curve is a rare event and represents an interest rate environment in which bonds of longer maturities have lower yields than those of shorter maturities of the same credit quality. In the last couple of weeks, we have seen the yield curve invert a number of times with the 10 year US Treasury bond yielding slightly less than its 2 year counterpart – for the first time since 2007. This announcement along with continuing headlines of a US-China trade war has brought about a new round of market volatility. A yield curve inversion is a significant event, as history has shown that inverted yield curves tend to be predictors of economic recessions, hence why they receive so much media attention.
RBC Capital Markets does point out that there are still a number of economic factors in place that would make the yield curve today a less accurate predictor of recessions, including the unusually low levels of global interest rates - easy credit is still flowing. There are also a number of economic indicators that are still flashing green suggesting that the US economy is still in expansion mode: Strong employment, lending, manufacturing activity and strong consumer spending.
RBC Wealth Management Recession Indicators suggest that only one of six measurements is flashing red (Yield curve inversion) while the other five still suggest a strong economy.
For more details on this event please read RBC Wealth Management’s recent update by clicking on the following link: Market volatility: It’s a mad, mad world.
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