Inverted yield – Investors bracing for impact
By Mario Reyna, STC Dean of Business, Technology and Public Safety
The inverted yield curve has been in the news a lot this week. This inversion happens when the yield on a 10-year Treasury note falls below the two-year Treasury note.
This inversion is nothing more than subtracting two numbers from each other – the 10-year note from the two-year note.
Yield is not the same as a fix interest rate. It is based on the demand of the Treasury note when the U.S. Treasury auctions them, or when they are sold in secondary markets. What does this mean and who cares?
Yield is the net return on the money invested in financial instruments. In this case, a Treasury note. Let’s look at an example.
Imagine $1,000 invested in a U.S. Treasure-note that returns $80 a year, wishful thinking, and has a yield of 8 percent. When the yield on 10-year note falls below the yield of two-year note, investors become worried about the future because for a long time, this has been an indicator that a recession is looming. The last time the U.S. experienced a yield inversion was in 2007, so we know what happens next. Also, the yield inversion has predicted recessions for the last 50 years.
The money that you have today, if you invest it properly, should be worth more tomorrow or next year. Whenever you invest money for an extended time, there is a particular risk attached to this scenario; therefore, the investors expect higher yields. No one can predict what is going to happen in a year much less 10 years. So investors who are exposed to riskier assets expect higher yields for their investments. A high yield represents the economy is doing great and is expanding, and lower rates mean the opposite. Trade wars, national debt, and deflation are concerns for investors that should concern the rest of the nation.
When the future does not look too prosperous, investors begin to pull back from specific financial instruments and buy less risky ones instead. A 10-year Treasury note is exceptionally safe because it is back by the U.S. government. So inventors begin to pour their funds into this type of asset in a hurry, to the point of accepting a lower but more secure return. Lots of people will lose their employment as well as the value of their current investments if and when this recession becomes a reality.
Other issues that have investors on edge are economic slowdowns in Europe, Mexico, South America, and China.
Investors know that China is a capitalist system without a democracy that has discovered how to use credit. So imagine what happens when credit runs out for the two largest economies in the world? Investors are beginning to get spooked, and it is clear why they would be. Hence money is flowing into a 10-Year Treasury note that is being sold by other investors at a premium in a secondary market, and that is causing the 10-year Treasury note’s yield to dip below the two-year Treasury note.
The bottom line is investors are worried about the economy due to too many unknowns. They like stability in economic systems to make the best decisions on their investments. The current trade wars, the national debt ($22.5T), and the looming recession for some European and South American nations have the investor class concerned. We should heed this notice and fasten our seat belts because it is going to get bumpy.