What Does an Inverted Yield Curve Mean to You?

 

You may have been hearing something about the inverted yield curve in interest rate markets. The term refers to a condition characterized by short-term interest rates being higher than long-term rates. The inversion can occur for manifold reasons. Whether it is one of the reasons, I don’t know, but one can observe that an inverted yield curve often occurs when debtors are struggling with their long-term debt and do not have the creditworthiness to restructure it. So they start borrowing short-term to make their payments. While doing so creates demand for short-term money that would drive up its price (i.e.: interest rate), I can’t say that it’s a significant cause of the inversion. More likely, it is a result of the factors that have caused the relatively high short-term rates in the first place.

When big money sniffs recession coming and sells stocks to invest the proceeds in treasury bonds, the effect is to drive up bond prices, which is the same as lowering long-term interest rates, or at least keeping them from rising as fast as short-term rates. I suspect there is a lot of that happening these days.

Short-term rates being high is indicative of illiquidity. People are struggling financially and looking for credit. This lifts short-term rates.

There is a correlation between inverted yield curves and recessions. In the past 60 years, I do not think there has been a recession in the USA and Canada that was not preceded by an interest rate inversion, and only one time in that period did an inversion fail to be followed by a recession. The recession normally begins soon after the inversion is righted, that is, once long-term rates have risen to exceed short-term rates, or short-term rates have fallen to below long-term rates. The current inverted yield curve is the canary in the coalmine, signalling and approaching recession.

The recession is already in Europe. It is also in China. Real estate is a very significant part of the Chinese economy, and housing prices fell 9% in July --- not 9% year over year, but 9% June to July. Chinese imports and exports are also down sharply. A recession is in China, and China in in a recession. The notion that China will be the engine that pulls our wrecked economy into the repair shop is folly. China is stumbling. In any case, we no longer like each other and do not play nice.

It’s a good time to do what you have to do to get ready for a recession.