July 20, 2024

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Stock market investors should watch this portion of the yield curve for the “best leading indicator of trouble ahead.”

Stock market investors should watch this portion of the yield curve for the “best leading indicator of trouble ahead.”

Investors have been watching the US Treasury yield curve for inversions, A reliable indicator of the last economic downturn.

They don’t always agree on that Which part of the curve Better to watch though.

“The yield curve inversion, and the settlement was at the forefront of everyone else,” Pete Duffy, chief investment officer at Penn Capital Management Company, in Philadelphia, said by phone.

“That’s because the Fed is very active and interest rates have suddenly gone up so fast.”

A yield curve inversion occurs when prices for longer bonds fall below rates for short-term debt, which is a signal that investors believe economic problems can lie in wait for them. Fears of an economic slowdown have mounted as the Federal Reserve begins to tighten financial conditions while Russia’s invasion of Ukraine threatens to keep key drivers of US inflation elevated.

Recently, attention has been focused on the 10-year Treasury yield TMUBMUSD10Y,
And a shorter two-year return, as the spread decreased to 13 basis points on Tuesdayup from a high of about 130 basis points five months ago.

Read: Yield Curve Accelerates To Invert – Here’s What Investors Need To Know

But this is not the only plot that investors are watching closely on the Treasury yield curve. The Treasury sells securities that mature in a range From a few days to 30 yearswhich provides plenty of plots on the curve to follow.

“The focus was on the ten and the two,” said Mark Heppenstahl, chief investment officer at Penn Mutual Asset Management, in Horsham, Pennsylvania, a northern suburb of Philadelphia.

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“I will hold out for the 10 to 3 month bond rollover before I turn extremely negative in terms of the economic outlook,” he said, calling it “the best leading indicator of trouble ahead.”

Watch 10 years 3 months

Instead of falling, that jump spread In March, it continues its upward trajectory since turning negative two years ago at the start of the epidemic (see chart).

The return spread from 3 months to 10 years is rising

Bloomberg data, Gulzer Investment Management

“The 3-month Treasury bill is really tracking the Fed’s target rate,” Gavin Stevens, director of portfolio management at Goelzer Investment Management in Indiana, said by phone.

“So it gives you a more compelling picture of whether the Fed has entered a restrictive state in terms of monetary policy, and therefore, it gives the possibility that economic growth will contract, which would be bad for stocks.”

Stocks fell on Friday, but with the S&P 500 SPX,
+ 0.51%
and the Nasdaq Composite Index,
It’s still up about 1.2% on the week. The three major indices are down 4.5% to 10.1% so far in 2022, according to FactSet.

By watching TMUBMUSD02Y in tenths and twos,
Spread, “You look at the expectations of where the Fed’s interest rate policy will be over two years,” Stevens said. “So, effectively, it works with a delay.”

On average, from the time the ten-and-second curve reverses, until “there’s a recession, it’s been about two years,” he said, predicting that with Unemployment was recently pegged at around 3.8%. That “this curve will reverse when the economy is really strong.”

The San Francisco Fed also launched the 3-month TMUBMUSD03M,
and the 10-year curve relationship is “its preferred prevalence measure because it has the strongest predictive power for future recessions,” such as in 2019, Back when the yield curve was giving warning signs of a recession more regularly.

“Did you see COVID coming?” Duffy said, about yield curve inversions earlier.

The most likely trigger was that investors were already in anticipation of a recession, with the US economy going through its longest expansion period ever.

“There are a number of these curves that you need to look at in their entirety,” Duffy said. “We’ve always said look at many of the signs.”