E The Inverted Yield Curve Is Actually Bullish

My favorite meme following last week’s yield curve inversion was captioned, “I survived the yield curve inversion.”

My favorite tweet (from @jfahmy) was, “The next Jobs Report should be very strong with the 50,000 "Yield Curve Experts" that were added this week.”

Last Wednesday, the day the Dow dropped 800 points, the yield curve inverted for a few hours. There is a lot to unpack in that sentence, so let’s get to it.

First, I have to briefly define what the heck a yield curve is so if you already know, skip the next three paragraphs.

The explanation

The curve is a representation, or plot, of the yield on bonds from the same issuer across all maturities for which it is issued. Typically, we talk only about the yield curve of U.S. Treasuries, although they do exist for many sovereign debt markets. Analysts looking at the U.S. version have the luxury of a robust curve with maturities running from three and six months, to one, two, five, seven, 10, 20 and 30 years.

The normal yield curve is upward-sloping, meaning that yields on shorter maturities are lower than yields on longer maturities. Investors are paid more to take the risk of loaning their money for longer periods of time.

When the curve is flat or downward-sloping, that’s when we think the economy is running into trouble. The downward-sloping curve is called the inverted curve. This frequently appears a year or longer before recession begins, but as they say, the inverted yield curve has predicted 15 of the last 10 recessions. In other words, it does not always work.

Inversion Therapy

OK, now that our more sophisticated readers are back with us, the curve got somewhat funky in April when the five-year yield dipped below the 3-month yield. Then in May, the three-month yield was above the seven year and then above the 10-year.

Some pundits called the three-month to 10-year condition the inverted yield curve. My opinion is that was questionable, at best. Why? See next paragraph.

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Disclosure: No positions in anything covered.

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