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What A Yield Curve Inversion Means For Traders

08 December 2018
What A Yield Curve Inversion Means For Traders

One of the most reliable warning signals for a recession just got a bit brighter.

The yield curve inversion and comments from Fed speakers are causing investors to rethink the potential of a recession or if rate hikes are nearing the top, said Minh Trang, senior FX trader at Silicon Valley Bank in Santa Clara, California. However, when investors expect interest rates to decline in the future - typically because of a weak economy - they scramble to lock in today's comparatively high interest rates for as long as possible.

In the current instance, investors and economists are debating whether this warns of economic weakness ahead or if it reflects other factors, such as a recent reversal of large speculative bets on declining bond prices and the Federal Reserve's large holdings of Treasuries.

The dollar trimmed some of its recent losses but remained under pressure on Wednesday, as an inversion in part of the Treasury yield curve raises concerns about a potential United States slowdown.

On Monday, 2- and 5-year Treasury yields inverted, meaning the shorter dated 2-year money became more expensive than the later maturing 5-year.

Concerns about slowing US growth have accelerated the flattening of the yield curve, a phenomenon in which longer-dated debt yields fall faster than their shorter-dated counterparts.

No, at least not yet.

President Donald Trump suggested Tuesday that he could extend a 90-day truce in his trade war with China, while his top White House economic adviser backtracked from the president's announcement that Beijing had agreed to reduce tariffs on USA -made cars.

Don't count on it. Japan has had numerous recessions where its yield curve did not invert at all.

The yield curve between two-year and 10-year notes flattened to 16 basis points, the flattest in over a decade.

Hong Kong's Hang Seng retreated 1.55 percent and the Shanghai Composite Index dipped 0.2 percent.

Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab.

The Dow Jones Industrial Average fell 799.36 points, or 3.1 percent, to 25,027.07, the S&P 500 lost 90.31 points, or 3.24 percent, to 2,700.06 and the Nasdaq Composite dropped 283.09 points, or 3.8 percent, to 7,158.43.

The Cleveland Fed, meanwhile, has focused on the difference in yields between three-month Treasurys and 10-year Treasurys. That particular inversion has preceded every recession since the late 1970s. But it also has not inverted, and a 10-year Treasury yields 0.50 percentage points more than a three-month Treasury bill. "If twos and 10s invert between now and December 18, the Fed is going to have to take out some of the hikes next year, or they should do it", said Joseph Lavorgna, chief economist of the Americas at Natixis.

The yield curve "tells me that it's wise to be patient here", Kaplan told Reuters in Laredo, Texas where he is meeting with business leaders and bankers.