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What is an inverted yield curve, and what does it mean?
Everyone’s talking about the inverted yield curve and how it could signal a recession. Robert Tipp, chief investment strategist and head of global bonds for PGIM Fixed Income, explains.
Just what is an inverted yield curve?
An inverted yield curve is when yields on long-term Treasury securities are lower than yields on short-term securities. Most of the time, yields on cash, money market funds, bank deposits and short-term Treasurys are lower than long-term Treasurys such as 10-year, 20-year and 30-year bonds. But there are times in the business cycle when short-term interest rates are higher than long-term Treasurys, and that’s called an inverted yield curve.
Why is everyone talking about it?
Historically, inverted yield curves have preceded economic slowdowns. So investors have been conditioned to worry about the onset of an inverted yield curve as potentially signaling the possibility of a recession and downdraft in the markets.
Why is this happening?
Two opposing factors caused the inverted yield curve. First, over the past few years, the Fed pushed short-term rates up about 2%. Second, long-term rates have fallen, pushing them a bit below the short-term rate, inverting the yield curve. While in past cycles the drop in long-term rates signaled investors’ concerns about a slowing economy, this time the drop in long-term rates has likely been exaggerated by the low level of foreign interest rates. Negative long-term rates in Europe and Japan have likely resulted in above-average demand for U.S. long-term bonds. This demand has likely pushed down long-term U.S. rates and contributed meaningfully to the inversion of the yield curve.
Is a recession coming?
While we can’t be sure, in our view the odds of a recession currently look quite low. The economy is growing reasonably well. The Fed has reversed course after its modest hiking cycle and is trying to foster growth by cutting rates. Unlike past inversions, interest rates are quite low—probably low enough to boost growth after their recent decline.
How is PGIM responding to the inversion?
We continue to be guardedly optimistic that we’re not facing an imminent recession. So we are taking advantage of opportunities in the market to get incremental yield in sectors we think will benefit from this economic environment of ongoing moderate growth and stable inflation.
Should individuals be making any financial moves?
Investors always face uncertainty. The best course is usually to stick with your long-term strategy and not make ad hoc adjustments based on the latest news headlines. At PGIM Fixed Income, we believe that’s the case today as much as ever. But you should talk to a financial professional about your own situation before making any moves.
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