Is flattening US yield curve a recession warning?
September 19, 2018

An inverted yield curve could be on the cards in the near future if recent trends in bond markets continue, but it might not signal a recession this time around, according to Adrian Hull, Co-Head of fixed income at Kames Capital. 

Rising short rates in the US are currently outpacing moves at the long end, flattening the yield curve, with market participants expecting further moves in the same direction. Traditionally over the last century, such an inversion of the yield curve has been seen as the amber light for a forthcoming slowdown, but Hull says the outlook this time is far less clear.

"The US Federal Reserve is spending a lot of time worrying about what an inverted yield curve might mean for expectations as well as economic reality," Hull says.

"Today, the sophisticated world of central banking and generic 2 percent inflation targeting provides stability; but as quantitative easing stops and the unwind drips the stock of bonds back to the market, we are in unchartered territory. 

Hull says as a result investors might have to look further back than the most recent history to give a better indication of the consequences of an inverted yield curve. 

"Analysis from BNP Paribas shows that up until the 1930s the yield curve was almost always inverted. Perpetual gilts traded at a premium to short-dated "call" money," he says. 

"Essentially, those people who had money didn't want the hassle of chasing higher yields from the lightly regulated banking system. They were happy to stay safe with gilts and let those who really needed money squabble for it at higher yields.

"No doubt this is a somewhat simplistic view of the materially less regulated world of late 19th century bond markets, but there are parallels with today. Regulation demands that a whole chunk of pension fund money is locked away for the long term in safe assets almost irrespective of the cost of call money, which is creating (as we have seen many times, and continue to see in long gilts) an inverted yield curve."

Hull says as a result of these changing dynamics caused by extraordinary central bank policies, this time an inversion might not be such a portent of tough times to come. "What if the patterns over the past almost hundred years are wrong? What if it's different this time?" Hull asks. 

"It might just be a little too easy to assume an inverted yield curve means upcoming recession this time around."

 





This site, like many others, uses small files called cookies to customize your experience. Cookies appear to be blocked on this browser. Please consider allowing cookies so that you can enjoy more content across fundservices.net.

How do I enable cookies in my browser?

Internet Explorer
1. Click the Tools button (or press ALT and T on the keyboard), and then click Internet Options.
2. Click the Privacy tab
3. Move the slider away from 'Block all cookies' to a setting you're comfortable with.

Firefox
1. At the top of the Firefox window, click on the Tools menu and select Options...
2. Select the Privacy panel.
3. Set Firefox will: to Use custom settings for history.
4. Make sure Accept cookies from sites is selected.

Safari Browser
1. Click Safari icon in Menu Bar
2. Click Preferences (gear icon)
3. Click Security icon
4. Accept cookies: select Radio button "only from sites I visit"

Chrome
1. Click the menu icon to the right of the address bar (looks like 3 lines)
2. Click Settings
3. Click the "Show advanced settings" tab at the bottom
4. Click the "Content settings..." button in the Privacy section
5. At the top under Cookies make sure it is set to "Allow local data to be set (recommended)"

Opera
1. Click the red O button in the upper left hand corner
2. Select Settings -> Preferences
3. Select the Advanced Tab
4. Select Cookies in the list on the left side
5. Set it to "Accept cookies" or "Accept cookies only from the sites I visit"
6. Click OK

An inverted yield curve could be on the cards in the near future if recent trends in bond markets continue, but it might not signal a recession this time around, according to Adrian Hull, Co-Head of fixed income at Kames Capital. 

Rising short rates in the US are currently outpacing moves at the long end, flattening the yield curve, with market participants expecting further moves in the same direction. Traditionally over the last century, such an inversion of the yield curve has been seen as the amber light for a forthcoming slowdown, but Hull says the outlook this time is far less clear.

"The US Federal Reserve is spending a lot of time worrying about what an inverted yield curve might mean for expectations as well as economic reality," Hull says.

"Today, the sophisticated world of central banking and generic 2 percent inflation targeting provides stability; but as quantitative easing stops and the unwind drips the stock of bonds back to the market, we are in unchartered territory. 

Hull says as a result investors might have to look further back than the most recent history to give a better indication of the consequences of an inverted yield curve. 

"Analysis from BNP Paribas shows that up until the 1930s the yield curve was almost always inverted. Perpetual gilts traded at a premium to short-dated "call" money," he says. 

"Essentially, those people who had money didn't want the hassle of chasing higher yields from the lightly regulated banking system. They were happy to stay safe with gilts and let those who really needed money squabble for it at higher yields.

"No doubt this is a somewhat simplistic view of the materially less regulated world of late 19th century bond markets, but there are parallels with today. Regulation demands that a whole chunk of pension fund money is locked away for the long term in safe assets almost irrespective of the cost of call money, which is creating (as we have seen many times, and continue to see in long gilts) an inverted yield curve."

Hull says as a result of these changing dynamics caused by extraordinary central bank policies, this time an inversion might not be such a portent of tough times to come. "What if the patterns over the past almost hundred years are wrong? What if it's different this time?" Hull asks. 

"It might just be a little too easy to assume an inverted yield curve means upcoming recession this time around."

 



Free subscription - selected news and optional newsletter
Premium subscription
  • All latest news
  • Latest special reports
  • Your choice of newsletter timing and topics
Full-access magazine subscription
  • 7-year archive of news
  • All past special reports
  • Newsletter with your choice of timing and topics
  • Access to more content across the site