Yesterday night, something very important happened - part of the U.S. Treasuries yield curve just inverted for the first time in more than a decade.
The spread in yields between the 3 and 5 year fell into negative territory (below zero) for the first time since 2007 with the 2 to 5-year yield following up. As we can see from the above chart from Bloomberg, the last time this happened was a year before the last market crash.
As we have explained in another article, yield flattening followed by yield inversion could be the first signal that the economy might be slowing down.
The most important yield curve to follow is the 2 to 10-year yield spread however yesterday’s move could be the initial sign that we are heading in this direction.
Yield curves have been flattening over the past two years and could have signalled investors’ concern that rising rates against a backdrop of slowing global growth could harm the U.S. economy.
When the yield curve turns to ‘inverted’ - where yields at the short end rise above those at the long end -- it has been a reliable indicator of recessions.
What does this mean to investors?
The inversion of the 3 to 5 yield curve on it’s own will not impact asset class performance in the short term. Normally it is the spread between the 2 and the 10 years (or 10 and the 30 years) which have a more meaningful impact.
Having said that however, this has to serve as a precursor that we are reaching to a point whereby volatility is on the rise (this can also be seen by just looking at this year’s market performance) and the record-breaking bull market is coming to an end.
In such circumstances, we have to make sure that we have different asset classes, sectors and regions as part of our overall strategy in order to gain in the short term but at the same time prepare ourselves and protect our portfolios when markets turn south.
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