Yield Curve

How do today’s cyclical conditions stack up with those accompanying other stock market declines? 

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The gap between the 10-year Treasury yield and the federal funds rate has narrowed sharply in the last year but remains a long way (~110 basis points) from inverting.

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Bond market volatility picked up quite a bit in May but the higher-low/higher-high pattern in the 10-year yield is still intact, indicating the primary uptrend has not reversed.

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The U.S. 10-year ended the month 15 bps higher but non-U.S. bonds fared much better with bond yields in Europe and Japan 4-5 bps lower.

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The calm appearance of the 10-year yield masked a big curve-flattening move that has accelerated the last few months.

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The stock market is often maligned as a poor economic forecaster, and it’s true the market has predicted several more recessions than have actually occurred.

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Despite the late reversal in rates and the yield curve, the flattening trend of the yield curve remains intact. The fact that longer-term bond yields have fallen while the Fed is raising rates brings back memories of the “bond conundrum” episode during 2004-2006.

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The U.S. yield curve has flattened in the last few months but remains a long way from inversion—an event that’s preceded each of the last eleven recessions.

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Our current view is the lift-off will be December or later. Assuming inflation will pick up and the Fed hikes the rate by the end of 2015, stocks will perform relatively well, with international stocks a better bet than U.S. stocks.

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The steepening move in the yield curve is prevalent across many countries and is primarily driven by higher inflation expectations.

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With the Fed policy approaching actual tightening, the market is trying to price in a rate hike in the next year or so. This is a rather typical market response.

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The short end of the yield curve sold-off to price in an earlier-than-expected rate hike, while the long end rallied as the prospect of tightening reduced longer-term inflation expectations.

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We measure the sensitivity of common stocks to changes in interest rates using Implied Equity Duration. Growth-oriented sectors tend to have higher duration than Value-oriented sectors, while regional differences are largely explained by interest rate and risk premium differentials.

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The global yield curve is in a sideways range bound pattern, indicating anemic demand for credit. An examination of developed and emerging countries confirms our “muddle through” view.

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A Risk Contagion is now underway, and we continue to stay defensive and favor higher quality assets within the fixed income space. A silver lining: When the Risk Aversion Index moves above 1, odds start to favor a decrease in risk aversion going forward. The bulk of the move is probably done.

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Doug Ramsey examines several once very reliable relationships between stocks, bonds, inflation, and commodities.

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Recession risks don’t disappear the day the yield curve rights itself....the “window of vulnerability” extends for quite some time.

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The yield curve has moved away from inverted status, leading many to conclude the possibility of recession has been avoided. However, a look at past recessions reveals that a reversal of an inversion typically occurs prior to the economic decline– ranging from 6 months to over a year in advance.

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Doug Ramsey steps in as guest commentator in this month’s “View From The North Country” to highlight what we currently see as the bullish arguments for the stock market and contrast those with the bearish arguments.

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It may be difficult for the economy to prolong its expansion, with the auto and housing sectors weakening, and consumer spending a big question mark. 

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