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Spread bets and CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

Should you panic about the yield curve?

Friday’s headlines were dominated by the inversion of one of the yield curves, and what this might mean in the coming months.

The yield curve is viewed as potential signaller of a coming recession. Friday’s session saw the yield on the three-month Treasury bond rise above that of the ten-year, partly as investors piled into bonds due to fears about growth concerns occasioned by the dire German manufacturing purchasing managers index (PMI).

The two-year/ten-year yield curve, the most closely-watched curve, has yet to invert, and going back to 1968, there is on average a period of 19 months before a recession begins. The S&P 500 itself peaks around seven months before a recession. An inversion is a signal to ‘proceed with caution’, not a sign to ‘sell everything’.

Crucially, this time around might be different. As a result of changing financial market regulations, banks and other institutions have to hold more liquid assets than in the past, in order to withstand another crisis. Pension funds and insurance firms are also still huge buyers of bonds to help sustain their payouts. As a result, the long-end of the curve continues to see a fall in yields, causing the curve to invert.

In addition, the Federal Reserve (Fed) is in no hurry to raise rates. Core inflation has remained steady around 2%, while headline consumer price index (CPI) has been declining since March last year. The Fed now believes that inflation can be allowed to run above target for a time, and this requires them to hold off on their policy of rate rises. So far there is no sign of a spike in inflation, and thus the Fed is content to sit on its hands.

The global economy has been through a tough patch of late, but European data is beginning to pick up, and US financial conditions remain supportive. In addition, fund managers have been cautious about buying equities, with the monthly survey from Bank of America Merrill Lynch (BAML) showing that managers hold their lowest amount of stock exposure since the latter half of 2016. Meanwhile, cash balances are at their highest level since 2009, with similar levels (but not as high) as in 2012 and 2016.

The market hit a new high for the year last week, then dropped 2%. This was greeted with howls of anguish, but it was entirely predictable, and remains the sort of pullback one would expect to see after a 20% rally. A new bear market looks unlikely, barring some kind of remarkable disaster. Even trade wars might start to drop off the radar soon, as the 2020 election looms and US President Donald Trump’s thoughts turn to his re-election campaign.

This information has been prepared by IG, a trading name of IG Markets Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.

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