The Inverting Treasury Yield Curve And The S&P 500

There was one major economic event that occurred last week and it shifted the forward-looking focus of investors, sending stock prices sharply downward as a result.

That event was the partial inversion of the U.S. Treasury yield curve that took place on Tuesday, 4 December 2018. A yield curve inversion occurs whenever the yield, or interest rate, of a longer term bond or note issued by the U.S. Treasury Department falls below the level of a shorter term bond or note. This kind of event is often associated with an increased likelihood of an economic recession in the future, when businesses can expect to experience falling levels of earnings and cash flow, which is why stock prices would fall in the current day even though any economic distress is only in the potential outlook for the future and is not as yet guaranteed.

For a quick recent history of the Treasury yield curve, check out TheFirsh's two-minute long animated chart of the curve's history since 1990. Recessions followed within 1-2 years of significant yield curve inversions that occurred in 1989-90, 2000 and 2006-07 (the animation ends at the end of November 2018, so it doesn't capture the latest inversion).

via Gfycat

On Tuesday, 4 December 2018, the yield of the 5-year Treasury dropped to be lower than the yields of the 2-year and 3-year notes. Although the amount by which the 5-year note dropped below the 2 and 3 year notes is small, the negative implications of the event were amplified thanks to the highly influential New York Fed branch president John Williams, whose unfortunately timed and tone-deaf hawkish comments promising additional short-term interest rate hikes well into 2019 prompted investors to shift a significant portion of their attention beyond 2019-Q1 to the more distant future quarters of 2019-Q3 and 2019-Q4, where the expectation is already well established that these quarters will experience a significant deceleration in the growth rate of dividends.

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