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Hi this is Michael Carlin president of Henry and Horne Wealth Management with your manage the funds podcast.
We’re gonna do the die easily digestible version and it’s got to be on a topic that is coming up every single morning every day. Any finance article. It’s either the number one article or it’s certainly in the top couple. It’s the yield curve in the inverted yield curve. I end up spending a good portion of my day now educating clients over and over again about what the yield curve is and when it inverted yield curve is. So what I thought I would do is spend hopefully the next 10 minutes or less going through what the yield curve is what the inverted yield curve is what it all means and then give you something that you can digest.
Replay understands that you have a jet a good general working knowledge of this really important concept in finance and economics. So with that let’s dive in. So the yield curve what they’re talking about is the interest rates on the United States Treasury bonds. So there are U.S. Treasury bonds are issued in lots of different maturities. The shortest being one month the longest being 30 years. OK. So the U.S. Treasury issues bonds between one month in length when they mature and then 30 years until they mature 30 years being the long one month being the short.
So far so good what you may not know and you may not be aware of is that. Investment nerds finance nerds econ nerds just like me pay really close attention to how much the one month Treasury in that 30 year Treasury and all the other months in between how much those treasuries are paying. And if you map it out in terms of the one month pays this much and then the two month and three month and one year and two year and five year if you map out all those U.S. treasuries on a graph you’ll come up with a yield curve a line.
In what you normally want to see in a normally healthy economy is that the Treasury is paying less interest on those short term bonds and they’re paying more interest on the long term bonds. Why. Well if you’re going to hold your money up and tie it up for a long period of time like 30 years you better pay me more than if we’re gonna tie it up for a month so you would expect in a normal healthy economy a nice gradual they call it positive sloping yield curve it looks like you’re climbing a hill that’s what you want to see.
So I put together a chart direct from the US Treasury’s Web site which shows that January 2017 we had a normal positive sloping yield curve where the one month U.S. Treasury was paying point eight point five percent or one half of 1 percent in the 30 year U.S. Treasury was paying 3 percent and there’s a nice positive sloping hill to climb yield curve where the longer the bond the more it paid in that was the sign of a one sign of a healthy economy. Great. Terrific. Fantastic. If you fast forward to August of 2019 what you’ll see is that one month is over 2 percent and the 10 year which right now is somewhere around one and a half one point four depending upon the day the day with which we’re recording it at somewhere between 1 at one point four or five and one point five and you’re baking more on your short term treasuries than you are on your longer term Treasuries.
It’s inverted in the inversion is critical because it tends to mean a bunch of things about the US economy which we’re gonna get into right now.
One of the things that people look at as well what’s the difference between that 10 year U.S. Treasury which again today is somewhere around one and a half percent in the two year U.S. Treasury. What’s the difference in terms of which one’s paying more and. It’s significant because that number finally hit zero likely we’re paying the same two year treasury and a 10 year Treasury it was like Whoa. And when that started to happen people automatically started to fear that a recession was coming. Which is unfortunate but it’s shocking and we we’ve been talking about this inverted yield curve.
And if you’re a regular podcast listener you know this we’ve been talking about this inverted yield curve for it least nine months in the fact that it looks like it’s going to happen. Here it comes here it comes. And you can see it. You can see this trend which started easily the beginning of 2018 finally came to fruition here recently. And if you look that’s the two year Treasury versus the 10 year and if you look at the three month Treasury versus the 10 year treasury that was even more dramatic where it you can really see this dramatic change and I’m happy to share these slides with you just certainly send us an email at firstname.lastname@example.org and we’ll send these things out to you right away.
But you can see that once it started to get negative which was right around March of this year it improved a little bit and then got negative again in an you know really that. June time period tried to improve in July and then here go in August it got a heck of a lot worse meaning more negative. The difference between the short term and the long term Treasury so why do people care. Because this inverted yield curve typically signals trouble here’s a huge huge note.
Pay attention not every economic indicator is perfect in an inverted yield curve is not a perfect economic indicator in inverted yield curve has signal nine out of the past 10 recessions meaning I’ll take it a step further.
You’ll hear that statistic. What that really means is that we’ve had 10 inverted yield curves and nine recessions meaning. We’ve for every inverted yield curve. It’s a definite signal but one time we had an inverted yield curve that didn’t come off the recession and this could be an inverted yield curve which we have right now that doesn’t come with a recession. But now you’re working with. Historically speaking since the 50s I 90 percent probability that it does mean a recession is coming and it’s it’s it’s interesting because the question becomes is how long will it be.
Once we get this inverted yield curve to when a recession starts and the answers are all over the board if you go back to the 50s in some cases once an inverted yield curve happens it’s 21 months before a recession. Sometimes when we get an inverted yield curve it’s negative one month before we get a recession hub. It could be 21 months or negative one month. The answer is yes. The average is six months. Well so what am I supposed to do is it gonna be six months is again. The point is we don’t know but it’s a signal that you can be reasonably sure that’s going to bring some some difficult times ahead.
And I’ve got a really nice chart that looks back into all the prior inverted yield curves including this one to say when does the market usually peak and when does the economy normally economy normally fall into recession to give you a greater understanding for for what the historical landscape has been and like recessions the peak of the stock market usually happens after an inverted yield curve. Well here we are we’ve had the inverted yield curve. We just had a new peak of the market.
So you have to ask the question is that it is that it does. So was that the market high.
And are now we facing a recession people still don’t understand even after hearing all this they say Well but why why does it why does it I still don’t understand. Great. So. OK. Inverted yield curve I know what you mean now I know what a yield curve is. I know it’s the U.S. Treasury and I get it. I can I can visualize the mountain graphic and visualize. I can visualize the inverted yield curve.
OK I got it I got it.
What’s the big deal the big deal is that banks borrow money short term and they lend money long term. So if they cost them I’m going to make this up but two and a half percent to borrow and they can lend it out at one and a half percent you don’t have to be an economics wizard to know what a bank will do when the cost to borrow is greater than the cost that they can loan the money out at they won’t lend and what happens when banks don’t lend the economy slows down.
Ta da! That’s this it that’s if you understand everything that I just said if you commit that to memory there is a huge part of economic theory that you have now just mastered.
We should send you a little patch a little commandment of achievement. It’s this is it there’s a lot of critical things that we hope to educate you want and this is something that we absolutely want to make sure that you know because because you do you do need to know it. So with that hopefully now you have a working understanding of what the yield curve is. You understand that it should be positive sloping short term Treasury rates should be lower hopefully than longer term rates and in in normal economy. But yet when things start to get a little weird and there’s a few reasons why things are weird I’ll talk about that for for just a second that that there’s economic circumstances where Oh no.
Short term Treasury rates are actually higher than longer term Treasury rates which can cause some problems for banks and lending institutions. One of the things that we don’t know.
I’m going to leave you with this and we’ll have to do a whole different due to a little education session on this at are our treasury rates being impacted unusually so by the influence of foreign money coming from overseas and buying our U.S. Treasuries and pushing the yields down. Is that why we’re having an inverted yield curve is is trouble with the fact that that Germany that just last week issued their first 30 year German government bond at a zero percent rate of interest that was so sought after that people paid more than asking price.
It was a negative yielding 30 year German Treasury bond. So.
What would you rather own. Would you rather own a 2 percent U.S. Treasury or a negative German 30. I think the answer is obvious.
So if you’re looking to put your money somewhere maybe just maybe a huge disproportionate amount of that money that normally would go to those kinds of German bonds or Swiss bonds or most of the developed world outside the United States bonds Japan and Denmark those places all have negative interest rates.
So ask yourself where would you put your money.
Would you want to earn a negative rate of return or something positive that I’d states and maybe that’s what’s drawing our interest rate our interest rates down. That’s what’s inverting our yield curve and maybe this is no big deal you’ll have to hear more about that in our market outlook which will be coming up here in the next number of weeks if you have any questions send us an e-mail at email@example.com. This is Michael Carlin president of Henry+Horne Wealth Management with your manage the funds podcast on the inverted yield curve.
Thanks and have a great day.
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