By CCN.com: Fifty-three percent of countries that offer sovereign debt currently have inverted yield curves, according to one economist. If the percentage gets much higher, there is a strong possibility of a global recession.
Daniel Lacalle, Chief Economist at the Madrid-based investment firm Tressis SV, delivered the news via Twitter:
Why An Inverted Yield Curve Is Really Bad
An inverted yield curve signals a recession because of what it says about investor psychology.
Normally, we expect yields on longer-term bonds to be higher than that of shorter-term bonds. That’s because the longer the time frame, the more risk that interest rates and the economy will change. To compensate for that risk in owning a longer-term bond, the bonds pay a higher interest rate.
Consequently, the shorter time time period to a bond’s maturity means less opportunity for circumstances to change, which means less risk, which translates to a lower interest rate.
Inverted Curves Spook the Markets
An inverted yield curve means short-term bonds are paying higher yields than long-term bonds. Short-term bonds are usually represented by two-year Treasury notes, and long-term bonds are usually represented by the 10-year Treasury note.
Investors purchase long-term bonds, which pushes those yields down. They’re willing to take less money over the long term because they do not see inflation as a risk. Inflation would drive interest rates up, meaning investors feel satisfied that their money will be safer in longer-term investments.
This also means investors expect the Federal Reserve to continue to lower interest rates. Consequently, investors want to buy long-term bonds and lock in higher interest rates before the Federal Reserve starts to lower them.
Inverted Curves Often Forecast Recessions
The reason an inverted yield curve is a frequent signal for a recession is that lower interest rates mean a cooling economy. The Federal Reserve lowers interest rates to encourage people to borrow money so that they can invest in their business or other ventures. That is meant to stimulate the economy.
Although an inverted curve is not always a signal for a recession, Kevin Smith of Crescat Capital points out that one is more likely if the Fed activity lags behind market signals and that “we see much bigger problems from a macro standpoint” in terms of equity prices falling significantly.
Ed Butowsky, Managing Partner at Chapwood Capital Investment Management, agrees that all of these inverting yield curves are a dire sign for the global economy, telling CCN.com:
“I don’t know how the Fed can’t continue to lower rates, to the point of returning to historic lows. The global economy is doing nothing but re-trenching, and that creates a contagion because of how linked every nation’s economies are to each other. Even China’s growth is half of what it was two years ago.”