The Treasury yield curve has inverted—short-term interest rates have moved above long-term rates. Or, more precisely in this case, long-term rates have fallen below short-term rates.
This has garnered a lot of attention because in past economic cycles “inversion” has proven to be a reliable signal that a U.S. recession was on the way—on average about 11 to 14 months from the date of inversion.
Long, bruising equity bear markets, not just in the U.S. but also in Canada, the UK, Europe, and Japan, have been associated with U.S. recessions. These bear markets have typically started months before the recession gets underway. That makes inversion of the yield curve a valuable early warning signal that a more defensive investment state of mind is called for.
Is the recession clock starting?
The debate is already raging as to what, if any, credence should be given to the yield curve’s signal this time. There are a number of arguments—some very compelling—asserting that this inversion has occurred for very different reasons than in past cycles and therefore can be safely ignored. Perhaps. But in our experience, arguments like this have always surfaced around the time of previous inversions and, even though the mechanical reasoning was often correct, a recession (and equity bear market) eventually arrived.
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