On Friday, March 22, 2019, the yield curve inverted when the yield on 3-month U.S. T-bills exceeded the yield on 10-year U.S. Treasury notes by 2.2 bps at the end of the trading day. As we noted in two of our 2018 quarterly letters, we have been monitoring the curve closely. Typically, long-term rates are greater than short-term rates, and the yield curve is “upward sloping.” In a very general sense, when the yield curve inverts, short-term rates rise above long-term rates, and the yield curve becomes “downward sloping.” Two potential reasons for a yield curve inversion could be that investors are fleeing to safety and buying up safe, long-term assets, driving up the price of these assets and pushing the “long end” of the yield curve downward (bond prices and yields move in opposite directions). Alternatively, overly aggressive central bank tightening could cause a spike in short-term rates, driving the “short end” upward.
Inversions of the yield curve are a major phenomenon to watch because they have preceded the last seven post-war recessions, with only two “false positives” (i.e., the yield curve inverted and a recession did not occur until after the next inversion). While an inverted yield curve often portends recession, the actual inversion is not, however, generally a signal to sell risk assets immediately. According to Bianco Research, the beginning of a recession (i.e., two consecutive quarters of negative GDP growth) follows the inversion of the yield curve by 311 days on average. Thus, we treat the fact that the yield curve inverted as one of many recent signals that have caused and continue to cause Delegate to recommend an increasingly conservative posture towards risk assets. Other troubling signals include the record high U.S. budget deficit and reductions in global GDP projections.
Because of these concerning signals, we continue to advise our clients to trim public equity and higher-risk fixed income exposures when appropriate, potentially to below policy targets, and to build cash balances to take advantage of market downturns.