What is an Inverted Yield Curve and Does it Matter?
March 28, 2019
By Sterling Neblett
Centurion Wealth Management
On Friday, March 22nd the yield of the United States Ten-year Treasury Note dropped below that of the Three-month Treasury Bill for the first time since August of 2007. This situation does not often present itself, but when it does; economists sit up and take notice. The green eyeshade gang notes that most often when the yield curve “inverts” an economic recession follows.
For clarification, the fluctuating quotes for yields on U. S. Treasuries refer to the total return for the period of time involved or yield to maturity (YTM). YTM takes into account the price paid for the bond ($1000+/-), the coupon rate of interest established when the bond was issued, and the exact length of time until maturity or redemption measured in days. Simple YTM calculators can be found online, but the pros often use their trusty handheld calculators for more exacting results.
The yield curve is so-named because it “normally” curves upward from left to right, from short to long, but no longer as of Friday. The current graph of yields from shortest to longest now slopes ever-so-slightly downward as it proceeds rightward from the three-month bill at 2.44% toward the ten-year maturity at 2.39%. This could be a tipping point for interest rate predictions and economic forecasts, but much depends upon whether this trend continues and for how long. The current yield curve as eyeballed from a distance would better be described as “flattened.”
Current U. S. Treasury Yield Curve
Previous yield curve inversions have preceded economic recessions, but buyers of long maturity bonds during yield curve inversions have not been penalized for their reactive investment decisions. The most extreme examples are found in the early 1980s when two yield curve inversions preceded two recessions in a very short economic timeframe, The Federal Reserve, led by Paul Volcker, raised the Federal Funds Rate to over 20%. Three-month Treasury Bills then yielded 18% while yields on the 10-year T-notes and 30-year T-bonds reached as high as 15%. Those many savers who bought the highest yields available made a historic investment blunder, while those happy few who bought and held 13% 30-year US Treasury Bonds, when last they were offered in 1984, beat the stock market averages for the next three decades with a single purchase. The 13% 30-year bond issued in 1984 paid $130 per year until 2014 then returned the $1000 investment upon redemption.
Again in the late 1980’s the yield curve inverted when the Fed Funds rate reached nearly 10% and the 30-Year Treasury paid 8.95%. When last the yield curve inverted in 2007, the Fed Funds Rate was 5.25%, the 10-year Treasury 4.71%, and the 30-year 4.87%. Interest rates that high have not been seen since and may not be seen again.