SLC Management and its affiliated investment managers will offer their alternative investment strategies to the U.S. high net worth market.
Helping investors meet their current cash flow and future capital appreciation goals.
Unlimited access to our bond offerings and dedicated, personal support
Customized portfolios selected and managed by professional managers
Partnering with select institutional managers
Expert advice, ongoing trade support, and transparent pricing
An emphasis on solid investment disciplines and specific asset classes
March 04, 2024
January 29, 2024
TOP
Financial Industry Insights from Advisors Asset Management
On December 04, 2018
The Perversion of Inversion
The inversion of certain maturities in the yield curve has increased concern about the acceleration of the end of this historic expansion. We have long held that the inversion is a key indicator, however, it must be put not only in context but also explained as to how the current cycle is exacerbating the potential timing of the signal.
Historically, the timing of the inversion has always given ample notice before the recession and market top occurs. Consider past 10-year and 2-year Treasury initial inversions and the subsequent recession and market tops (Russell 3000 used as it covers 98% of all traded equities).
10-2 Inversion
Recession
Delay
Russell 3000 Top
Feb 2006
Dec 2007
22 months
Oct 2007
20 months
Feb 2000
Mar 2001
13 months
Mar 2000
1 month
Dec 1988
July 1990
Average
18 months
13.6 months
Source: AAM | Data from NBER, Bloomberg and Russell Investments
If all else being equal, the market and economic actions that need to be taken have the potential to be pushed out for a year and a half. However, there are certain anomalies that have occurred that make the current reading more premature than normal.
The balance of these measures are arguments for a potential Treasury put perception that has flattened the shape of the curve. However, another issue is quantitative easing in Japan and Europe. As their sovereign debt yield compared to U.S. Treasuries becomes a comparison for a risk-off move, a 10-year German Bund unhedged yield of 0.26% and a Japanese 10-year government unhedged bond at 0.08% makes a 2.93% U.S. Treasury unnaturally attractive. Yet, the foreign demand has not risen relative to U.S. households who have accumulated $1.8 trillion in U.S. Treasuries, up from $400 billion only a few years ago. Should the rates in Europe and Japan increase even slightly, we would expect more pressure on foreign demand for Treasuries…and thus more pressure on shifting outward on the curve, or at least giving an earlier signal of an inversion than normal.
Lastly, there are two charts that seem to have gone completely unnoticed when tracking the Federal Reserve’s Fed Funds Rate and how it compares to the 2-year Treasury and the Real Rate at the start of recessions.
Currently, the 2-year Treasury is 55 bps (basis points) above the Fed Funds Rate. At the start of each recession it was either at its most negative or coming off its most negative spread. At the most benign negative spread, the current 2-year Treasury would have to be 140 bps below the Fed Funds rate to trigger an immediate recession. Assuming the higher end of the Fed Dot Plot, a Terminal Fed Funds Rate of 3.50% (five more quarter-point hikes from here ending in early 2020), one would have to see the 2-year yield drop to 2.10% from its current 2.81%.
Lastly, the measure of the Real Fed Funds Rate just recently went negative. The Personal Consumption Expenditure year over year, minus the Fed Funds Rate, now stands at -47 bps. For comparison, the average over the last 30 years is -113 bps. Historically, it hits an average negative yield of -445 bps prior to the start of a recession – or 400 bps from here.
These charts from Bloomberg display that we have several metrics that likely are a significant period away from warranting a heightened level of anxiety based on the curves. We believe the conclusion one should make is that the current inversion of several curves only affirms an extremely early signal. While the markets are displaying risk-off moves and it looks to continue through year end, putting on snow tires in the middle of August seems a bit premature.
CRN: 2018-1204-7086R
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.
topics
Be the first to read our latest posts.