Because I Was Inverted - The Inverted Yield Curve
Recently I saw the trailer for Top Gun 2. I love the original Top Gun movie. I'm not sold on the sequel - are they ever any good?
One of my favorite lines from the original Top Gun movie occurs when the Top Gun class is in session outside and Charlie is debriefing the pilots on the MIG fighter jet. Maverick interjects and well…watch for yourself.
"Because I was inverted."
Man, I love that line.
Today, you might be hearing some talk about the term "inverted" in a different fashion, as in the inverted yield curve.
An inverted yield curve is a reference to bonds. More specifically, an inverted yield curve happens when it costs more money to lend at shorter term rates than it does at longer term rates.
Typically a bond will pay a higher interest rate for longer terms. And that makes sense. Here’s why:
If you gave me money and I promised to return it in one week, you wouldn't require a lot of (if any) interest on that money. But if I promised to return it in 10+ years, you'd probably want a higher rate of interest. After all, you aren't getting your money back for 10+ years. And it's possible you don't get it back at all. So a smart investor (you!) wants to be compensated nicely for those risks:
The lost use of your money for the next 10+ years
The risk of not getting it back
Simply put, that's why a longer term bond should pay more interest than a shorter term bond.
Sometimes - like our current environment - the bond market gets a little wacky and short term Government bonds pay or cost more than a longer term Government bond. In fact, it's only happened 9 times when the 10-year Treasury bond has paid less than the 2-year Treasury. This current environment marks 10 times.
So what is this telling us?
It can tell us many things, if we look for them. One headline you might read is this indicator has a pretty good track record of happening before a recession. It doesn't predict a recession per se. But in the past when it's happened, a recession has followed any time from shortly thereafter up to roughly 24 months later. So there's that.
On the contrary, you can also read suggestions refuting this "trend" and pointing to other measures causing our inverted yield curve.
Two points to remember:
We are not market predictors
We could imagine these short term rates might be running high because tight monetary policy is slowing the economy. Or we could surmise that investors (read: day traders, stock pickers) are worried about long term growth and are pushing down the long term rates reaching for the safer, longer term Treasury bonds. We might imagine it could be a reaction to policy making or that negative bond yields in Europe & Japan have reached into the US bond market and pushed down Treasury interest rates. Or who knows what else it could be. No one knows, really.
And since we can only use indicators for informational purposes, we are going to turn to our second point.
This is an opportunity to focus or refocus on financial factors we can control.
Where are you in your financial journey?
Does your income depend on the stock market? If so, will you be able to meet your income needs in the event of a market decline?
Does your spouse's or your income depend on a strong economy? Is your pillow money sufficient in the event of a job loss or reduction in income?
Are you comfortable with where your money goes, and why?
Maverick and Goose used their time being inverted as an opportunity to "communicate." While I don't suggest keeping up with foreign relations in the same manner as Mav & Goose, I do think our time being inverted is a good time to communicate as well. Check in with your spouse, check in with your financial advisor.
We can’t control if/when we experience a recession.
We can control how prepared we are if/when we do experience one.
Have questions? LMK or schedule a time to talk.