Worrisome sign? or Not?The yield curve has been inverted for a considerable period of time. Many investors consider this a sign of an impending recession. Quite some time ago I posted that I don't hold that view but rather look at the track of the size of the inversion and the trend in the steepness of the curve. Yeah, I know I am outlier in this regard.
In that vein, the recent activity in the bond market has been interesting to say the least and quite frankly is a bit of a headscratcher for me. The 10 year US Treasury Bill rate has climbed about 20 basis points in the last week while the 2 year has stayed relatively constant and thus has reduced the steepness of the inversion.
Normally, such a reduction in the steepness of the inversion would be a positive sign for the market and a signal to get ready to reduce cash positions and increase equity exposure. The problem is that the usual way for the steepness of the yield curve to become flatter is through the 10 year staying relatively constant and or maybe reducing a bit and the 2 year rate declining at a faster rate.
If all this is mumbo jumbo to you stop reading here...lol
One interpretation of what is going on right now would suggest that the bond market is anticipating a 25 basis point rate hike in the Fed discount rate very soon and this increases the chances of recession. So when you put these two themes together you get a mixed signal.
What is my interpretation?
Good question...
I think we are in some sense in uncharted waters or at least a unique situation to the extent of my recollection over the past 50 years or so of investing. The US Government, based on the CBO forecast will be running 2 trillion+ dollar annual budgetary deficits over the next 10 year (and longer IMO but the CBO only goes out 10 years). This is a lot of borrowing in relative terms compared to historical levels and significant enough to actually distort the normal bond market since so much depends on what maturities the US Treasury Department decides to borrow the money. The problem is that with this potential distortion by the US Treasury it is really hard IMO to figure out what is going on.
A lot really depends on one's tolerance to risk and investment objectives, but a basic rule of thumb that I have used over the years (and on balance successfully) is that when something is going on that I don't understand then I sit it out until things become clearer and I have a more definitive roadmap to follow.