Inverted we go

It’s hard to ignore this inverted yield chart. Record setting, for the wrong reason, is nothing to celebrate. Quite opposite, it could be the warning signal to dread. We’ve been inverted now for so long I nearly stopped paying attention until this chart smacked me across the face. We’re now on the extreme end of this data point and history doesn’t look favorable upon long periods of curve inversion. As the graph shows, the higher the spike in the blue line, the worse the red shaded area of recession tends to follow. The scariest of recent inverted episodes, and the previous record holder, has to be the ‘08 - ‘10 subprime recession. Could we be headed for a major correction? If history serves as a guide, yes. The inverted yield curve is a near perfect recession indicator. And as the graph shows, the more days inverted, the bigger the recession to follow. The evidence is pretty compelling. It could pay to be weary of what may come next.

With the 10Y yield on the march, up nearly 100 bps in the last six months, the inversion has lessened somewhat. Today, the 3M T-bill rate stands at 5.33% vs the 10Y yield at 4.43%. Comparatively, it’s a 90 bps spread. Six months ago, during the early days of inversion, the 3M T-Bill rate stood at 4.63% compared to the 10Y at 3.40%, a spread of 123 bps.

Considering we’re at records days of inversion, and the spread is still pretty wide, the inversion period appears nowhere near finished. What could change? The Fed could drop rates, influencing the short end of the curve, although the Fed just reiterated it’s “higher for longer” narrative at the FOMC meeting last week. Alternatively, the 10Y could go on a tear, rising up to 100 bps to fix the inversion, assuming no movement on the 3M if the Fed sticks to its word. A 10Y north of 5% has it’s own set of ripple effects knowing how many loan products, including the government’s massive debt load, are tied to this rate.

A more realistic end to inversion is some further tightening on the 10Y and some loosening on the 3M, a scenario most project for mid-2024.