Market Update - Yield CurveSubmitted by Texas Legacy Wealth Management on August 14th, 2019
On 8.14.19, a closely-watched recession signal flashed red with the inversion of the 10YR-2YR US Treasury yield curve, another part of the yield curve to invert. An inversion of the yield curve means that long-term rates are lower than shorter term rates (in this case the 10-year US Treasury vs the 2-year US Treasury). This has led many in the financial media to announce that a recession is inevitable. While we watch the 10yr-3month yield curve on our economic dashboard, this is just a further warning sign we will be watching carefully as we get longer in the economic cycle.
An inversion is seen as a potential symptom of a sick economy and has generally been a reliable indicator of a recession; however, the inversion of the yield curve has not historically been a good timing indicator. In fact, a recession occurs, on average 22 months following an inversion of the 10-2 yr yield curve (Credit Suisse, CNBC), while stocks have often continued to move higher as can be seen in the chart below:
We agree that the inversion of the yield curve is a troubling sign, and is currently the only data point in our economic dashboard flashing red. We will continue to monitor economic data along with other major risks including the ongoing trade war, Brexit, central bank policy, and other geo-political risks such as the recent Hong Kong protests. While we believe the economy is unlikely to move into a recession immediately, we do feel that there are increased risks of a recession looking out beyond this year, and we stand ready to make changes to portfolios as needed.
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* The 10-year Treasury Note represents debt owed by the United States Treasury to the public. Since the U.S. Government is seen as a risk-free borrower, investors use the 10-year Treasury Note as a benchmark for the long-term bond market.
* Government bonds and Treasury Bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.
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* Typically, the values of fixed-income securities change inversely with prevailing interest rates. Therefore, a fundamental risk of fixed-income securities is interest rate risk, which is the risk that their value will generally decline as prevailing interest rates rise, which may cause your account value to likewise decrease, and vice versa. How specific fixed income securities may react to changes in interest rates will depend on the specific characteristics of each security. Fixed-income securities are also subject to credit risk, prepayment risk, valuation risk, and liquidity risk. Credit risk is the chance that a bond issuer will fail to pay interest and principal in a timely manner, or that negative perceptions of the issuer’s ability to make such payments will cause the price of a bond to decline.