This Time is Different
Hey There,
The most widely followed yield curve has just un-inverted.
This is quite a rare signal that's almost perfectly predicted every recession in modern history.
The 2008 Financial Crisis, the 1970s downturns, even the 1929 Great Depression - this indicator caught them all.
In fact, the yield curve un-inverted in October 1929, right before an 80% market crash.
Yes, that was a hundred years ago!
While some might argue “this time is different,” history suggests those words are often quite costly.
Historically, when the yield curve un-inverts, it’s not good news for stocks.
These un-inversions have often occurred right before major bear markets, ike 1929’s 80% crash, the dot-com bubble’s 50% drop, and 2008’s 60% collapse.
Of course, there are exceptions.
For example, in 1979, stocks kept climbing even as a recession took hold.
Now, since 2023, people have pointed to the inverted yield curve as a recession warning.
Yet, no recession has arrived, and we’ve seen one of the strongest market rallies in history.
So, with the curve un-inverting now, is it finally time to turn bearish?
Let’s take a look.
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10-Year Minus 3-Month Yield Curve
It’s worth noting that there are many types of yield curve that exist, each based on different bond maturities.
Interestingly, several already un-inverted back in July 2024.
The 10-year minus 3-month yield curve matters because it combines 2 crucial elements.
The 3-month yield tracks Federal Reserve actions - they can move it up and down as they wish.
Whereas, the 10-year yield is controlled by private investors and is considered a proxy for the neutral rate.
Understanding the "Neutral Rate"
The 10-year yield is considered a good indication of the "neutral rate", which is the ideal interest rate that's neither too high nor too low for the economy.
When the Fed’s interest rate is below the neutral rate, it means that the economy is being stimulated.
That environment is what's called loose monetary policy.
But, when the Fed rates go above this neutral rate, they're tightening policy and often sowing seeds for recession.
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When the Fed begin to lower interest rates again, that's usually because the economy is slowing down significantly and heading into a recession.
That’s when the yield curve un-inverts.
Recent Yield Curve Un-Inversion
Very recently, the yield curve has un-inverted, just like it did before the last 3 recessions.
But today’s un-inversion stands out because unlike the past instances, the 10-year yield has actually been rising recently today.
That’s a big difference.
In the last 3 recessions, the 10-year yield fell sharply before the downturn began.
That is exactly what you would expect though.
You see, historically, GDP growth and the 10-year yield are very tightly correlated.
So, it's only natural that when GDP growth is declining, that you would see the 10-year yield declining at the same time.
Today's rising 10-year yield suggests that bond traders are not worried about imminent recession.
So, should we ignore this yield curve un-inversion?
We probably should not ignore this un-inversion.
If we put the unemployment rate over the yield curve, it shows that we’re still near the end of the business cycle.
In fact, the unemployment rate has already started to tick up and it’s possible that if the yield curve continues to steepen, the unemployment rate could move higher, triggering a potential recession.
That said, rising bond yields likely means that any potential recession is at least delayed right now.
Markets are pricing in economic resilience, so we might have more time before a prolonged downturn begins.
But for stocks, higher bond yields have often led to a market pullback.
So, today’s rising 10-year yield could bring some short-term volatility in markets.
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While keeping some hedges in place for protection, our active trades maintain a net long market exposure.
With the recession timeline extended, it seems like any market volatility is a potential buying opportunity.
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