Is the Yield Curve Flashing Recession?

Is the Yield Curve Flashing Recession?

March 25, 2019

By Michelle Holmes, CFA
Assistant Vice President - Investments 

The Federal Reserve (Fed) made good on its promise to be patient by keeping rates steady at the Federal Open Market Committee (FOMC) meeting last week. This was the first break in the pattern of hiking rates at every other meeting since December 2017. When it comes to adjusting interest rates, the Fed is officially on pause.

Recap of the Fed’s Policy Meeting

The surprise came in the FOMC meeting statement and accompanying economic projections. The Fed acknowledged that although the labor market remains strong; economic activity decreased, and indicators show household and business spending are slowing. This combined with inflation remaining at or below the Fed’s two percent target caused it to change course from a few months ago and pause raising rates.  

Even with the slowing economic growth, the Fed Chairman Jerome Powell remained upbeat about the overall economic expansion saying, “The U.S. economy is in a good place and we will use our monetary policy tools to keep it there.”

At the December 2018 meeting, FOMC committee members projected two rate hikes for 2019 and one for 2020. By the March 2019 meeting, most members saw only one more rate hike in the next three years. In fact, eleven of the seventeen members project no interest rate hike in 2019.

Chairman Powell said, “it may be some time before the outlook for jobs and inflation calls clearly for a change in policy.”

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How Did the Markets React?

U.S. Treasury note interest rates fell. The two- and ten-year notes fell over eight basis points (8/100 of 1%) after the Fed meeting.

 

US 2yr Bond YieldUS 10yr Bond Yield

While the very short end of the yield curve increased. The three-month U.S. Treasury bill gained one basis point.   

3m TBill Yield

Yields continued to fall through the rest of the week resulting in more of the yield curve being inverted. The ten-year U.S. Treasury note is now yielding less than the three-month U.S. Treasury bill. Many, especially those in the academic world, use this measure as a recession indicator. However, before you hit the panic button, note that the yield curve is not fully inverted. The spread between the ten-year and the two-year U.S. Treasury note is positive. Wall Street tends to rely more heavily on this spread as the primary recession indicator.

UST Curve

What Does it Mean for the Rest of 2019

Even if the yield curve is flashing red, it doesn’t mean that a recession is around the corner. A yield curve inversion is an early indicator meaning the economy could continue to increase for a couple of years before a recession begins. Market returns tend to be strong leading up to and coming out of a recession. It is important to stay invested even in times of higher volatility. Becoming too cautious, too early, can lead to a shortfall in meeting long-term goals.

Security National Bank’s outlook for 2019 remains the same. The economy is slowing but continues to grow. The Fed’s own estimate is slightly over two percent growth for the U.S economy in 2019. The labor market remains strong, unemployment is low, and inflation is near the Fed’s long term target. The current business cycle is unlikely to end in the near term.

Portfolios under management at Security National Bank will remain fully invested. A portfolio with a diversified mix of stocks and bonds has historically provided market like returns with less volatility over longer periods of time. When uncertainty increases, it is important to review your long-term goals and see if your portfolio is diversified and allocated properly between stocks and bonds to meet those goals.

Call today to schedule an appointment to review your portfolio.

About the Author

Michelle Holmes, CFA

Michelle Holmes is an Assistant Vice President in Investments with Security National Bank's Wealth Management Division. A Chartered Financial Analyst® charterholder, Michelle has two decades of investment experience. She graduated from Morningside College with a Bachelor of Science in accounting, business administration and economics.