Inverted Yield Curve
Igor Manukhov - Oct 20, 2023
The yield curve is normalizing, but a bit differently this time. Use market weakness to buy.
Over the last year and a half we lived through an inverted yield curve regime. In plain language, shorter term GICs were paying more than longer term GICs. An inverted yield curve tends to predict recessions because the FED usually gets it wrong and hikes rates too much. When the FED hikes rates they can only directly impact short term rates, all other maturities are adjusted by the demand of the market. If a lot of people want to buy long term bonds, long term rates go down and vice versa.
So, an inverted yield curve occurs when the FED is raising rates and the market buys a lot of long term bonds in anticipation of economic slow down. Those instances are shown on the bottom panel of the chart below. The yield curve get inverted when the pink line goes below the horizontal blue line. Notice when the pink line goes back above the blue line afterwards, the stock market does poorly.
Should we be concerned now that the yield curve is normalizing? I don't think so. Normally during market selloffs, the FED starts to cut rates aggressively while long term rates remain relative unchanged. That's what usually brings the yield curve back to a normal/upward sloping state. This time something else is happening. The yield curve got inverted because the FED raised rates aggressively, however the bond market responded by pushing longer term yields down. Now central banks are talking about the end of a hike cycle but longer term yields are starting to rise. That happens when there is less demand for long term bonds, which makes no sense if people are genuinely worried about a recession. High yield spreads are also relatively tame at the moment.
This is why I think that we are still in the early stages of this bull market and I would use temporary market sell off’s to accumulate great assets at attractive prices.
