The Recent Yield Curve Inversion May be Less than Meets the Eye
The Fed took more than a few people by surprise several weeks ago when it suddenly signaled there would be no interest rate hikes in 2019. Especially when it pointed to “slower growth of household spending and business fixed investment.”
Then, in seemingly no time at all, the yield curve inverted. Anyone will tell you that when long-term interest rates drop below short-term rates, it can only mean one thing: impending recession. But does it really? Sure, an inverted curve has preceded each of the past four recessions. But look at all the positive fundamentals this time around. Full employment, low inflation, sustained if slightly slower growth, and plenty of other indicators blinking green, not red.
As with so much other conventional economic wisdom that’s been turned on its head in recent years, there’s a good chance the recent yield curve inversion may foretell a more benign result. Perhaps a soft landing instead of a recession. Or maybe even just a temporary slowdown followed by a pickup in growth.
These kinds of questions can create headaches for cash managers sensitive to the slightest changes in short- and long-term rates. That’s why our April research report takes a deep dive into current interest-rate dynamics.
Our report—With the Fed on Hold and the Yield Curve Inverted, Thoughts on Cash Investment Portfolios—explains why the FOMC’s March meeting was a market-moving event. The Fed simultaneously suspended interest-rate increases and ended its long-term balance sheet reduction program. This extremely dovish about-face was a decisive turning point in the monetary cycle, which had been tightening since 2015.
Some have been reading recession in the tea leaves. But others saw temporary overreaction to the Fed’s unexpected move. Our report advises cash managers to pay heed to both points of view by maintaining laddered portfolios in separately managed accounts to improve liquidity and investment opportunities.
We also advise a hard look at credit risk. There’s no doubt that after years of easy money, many borrowers are overextended. A temporary slowdown, even one short of a full-blown recession, may be enough to knock many of those credits off kilter. Our message to managers: keep your eyes peeled, especially for eligible investments that may be overextended, even if they fall within your investment policy’s guardrails.
For more advice on how to understand these and other mysteries of the current interest-rate environment, download our April research report.