Experts: Keep The Yield Curve Inversion In Perspective

U.S. markets fell on Wednesday after the yield on the 10-year Treasury note fell below the yield on 2-year Treasury notes on Wednesday morning for the first time since 2007. According to the San Francisco Fed, each of the nine U.S. recessions that have occurred since 1955 came between six months and 24 months after an inversion in the yield curve of two-year and 10-year Treasury yields.

The S&P 500 closed down 2.93% at 2,840.60, while the Dow Jones Industrial average closed lower by 3% at 25,479.42. The Dow's 800-point drop is its biggest loss of the year.

Despite the negative knee-jerk reaction to the news, most market experts are sharing a more measured response to the inversion.

See Also: Recession Warning? 2-Year Yield Tops 10-Year Rate For The First Time Since 2007

No Reason To Sell

Tom Essaye, founder of Sevens Report Research, said investors should remember that stock prices didn’t peak until at least six months after the past three 10-year/2-year yield curve inversions.

“So, while the inversion is certainly a disconcerting signal over the medium and longer-term, it’s not a signal to necessarily ‘sell now,’ because a lot can happen between now and six months or more,” Essaye wrote.

Essaye said the inverted yield curve is a bad sign for investors hoping the recent Federal Reserve interest rate cut was similar to the preventative rate cut that it issued in July 1995. The U.S. avoided a subsequent recession in that case, but yield curves never inverted.

Economic Numbers Solid

LPL Financial Chief Investment Strategist John Lynch said investors shouldn’t dismiss relatively stable U.S. economic numbers just because of the inversion.

“The U.S. labor market is at full employment, healthy wage growth is fueling strong consumer activity, and corporate profits are at record levels,” Lynch wrote.

Lynch said U.S. financial conditions are extremely loose compared to historical norms, yet there are few signs of excess in the economy. He is not concerned a U.S. recession is imminent.

Trade War To Blame

Joseph Brusuelas, chief economist at RSM US LLP, said the trade war between the U.S. and China is the clear catalyst for the inversion.

“While the U.S. economy is not yet in recession–we would need to see an increase in first-time jobless claims, monthly job gains below 100,000 on a sustained basis (which would send the unemployment rate higher) and a move below 50 in the ISM Services Sector survey to indicate a recession has begun–the inversion of the yield curve and the appearance of real negative yields clearly indicates that the business cycle has entered its final stages and recession risks are elevated,” Bresuelas wrote.

He said economic risk will remain elevated until the trade dispute between the U.S. and China are resolved. Brusuelas also pointed out that 10-year U.S. Treasury notes are now yielding negative 0.2% on an inflation-adjusted basis.