What the US Treasury Yield Curve is Telling Us

To nobody’s surprise, the S&P500 continued to melt up. Last week it climbed another 0.35%. Volume was light. And volatility was almost non-existent: the VIX index closed back down below 10, which historically has rarely been reached.

The technical picture remains unchanged from last week—the S&P500 is a market that’s extremely over-stretched on the daily and weekly resolutions. Last week’s modest advance in the index did nothing to change this condition.

In US macro news, most of the reports were disappointing. International trade missed. PMI services and ISM services also both missed. Productivity came in lower than expected; as a result, unit labor costs rose more than expected. consumer sentiment disappointed. Wholesale trade missed badly. And in the US payrolls report for November, the average hourly earnings were lighter than predicted. On the positive side, factory orders fell less than predicted. Consumer credit grew more than expected. And in the payrolls report, more jobs were created, and the average workweek was slightly longer than expected.

Recently, market analysts have spotted an interesting development in the US yield curve. While the curve is still positively sloping (ie. the 10 year Treasury is yielding more than the 2 year UST), the difference between these two maturities has been collapsing over the last couple of years. This is important because in almost all of the most recent market and economic slowdowns, something similar has also happened…but well before these slowdowns actually hit. Specifically, the 2 year and 10 year have always inverted; that means that the 2 year yield exceeded the 10 year yield, creating a downward sloping yield curve.

Even more interesting was the timing of this development. The most recent two yield curve inversions preceded the subsequent market and economic retreats by about 18-24 months. So while today’s curve is only approaching inversion, when it finally arrives (and the Fed’s rate hikes have been the key driver of the recent curve flattening) when the Fed raises short-term rates several times over the next 12 months, history shows that a market slowdown is almost sure to follow….but only 18 to 24 months after the inversion first appears.

So is the yield curve telling us that the bull market in US risk assets has another two years to go?

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: