by Charles Cheng, CFA
Markets took a tumble at the start of the last week of March, and the financial press blamed the US Treasury yield curve as the trigger. The spread between the 3 month Treasury Bill and the 10 year Treasury note became negative for the first time in over 10 years. This has traditionally been noted as a pre-cursor to a US recession and indeed, the last time this happened was in 2007, shortly before the global financial crisis. But should investors think about taking action based on this single indicator?
Yield curve inversions are rare enough that we can easily look at the historical record of them in the past century compared to the frequency of recessions. The past nine recessions since 1955 have been preceded by a yield curve inversion. However, the most commonly looked at spread on the yield curve are between the 2 year and the 10-year Treasury notes, and that has yet to invert.
Some indicators do take into account both the 2 year and 3-month Treasuries on the short end of the curve. Tim Duy, author of Fed Watch, estimates the probability of recession in the forward six months based on their spread with the 10-year Treasury as well as on initial unemployment claims, and that probability has risen to risky levels.
In the 1990s, the indicator crossed this level multiple times without a recession, but at the time the Fed had quickly lowered rates in response. It remains to be seen what actions they take this time.
Is it worrying? Yes, a little bit. But we should still keep our eye on a range of indicators regarding the health of the economy, as it can still go a number of directions.
Mr. Cheng is a managing partner at a Hong Kong based independent private investment office. This article reflects his personal views and not his firm’s and should not be viewed as an investment recommendation.