The inverted yield curve: Is it different this time? 


The recent inversion in the US yield curve may be a reason for investors to worry, but a recession may not be as close as feared, experts have said. 

Peter Elston, chief investment officer at Seneca Investment Managers, appeared on the FTAdviser Podcast alongside David Thorpe, investment reporter at FTAdviser and Financial Adviser to discuss the implications of the inverted yield curve and whether ‘this time it is different’.

Mr Elston said: “The reason the inverted yield curve has become steep is because we have seen a huge decline in bond yield whether it’s in the US or in the UK, Japan or EU countries.” 

He added: “That decline we have roughly seen since November last year reflects the fact that people are getting very concerned about the prospects [of] the global economy.”

A yield curve is a visual representation of how much it costs to borrow money over time, and is typically upward sloping. 

This relationship flipped in March this year when shorter-term US treasuries became more expensive than long-term bonds. 

In August, yields on two-year US Treasury notes were more than five basis points higher than those on the 10-year government bond. 

An inverted yield curve has preceded every US recession since the Second World War. 

Mr Elston said that the average time between the yield curve inverting and a recession occurring was about a year, but he stressed he expects US growth to only plummet in early 2020, rather than for an actual recession to take place. 

A recession is formally defined by two consecutive quarters of negative economic growth. 

“There are a number of people citing that the yield curve does not have the same meaning that it did before,” Mr Elston said.

He added: “One of the people saying the meaning of the US curve has changed is Ben Bernanke, [the former Fed chairman].  But then he was the chap who famously before the financial crisis said there were no signs of a housing bubble.”

He said he expects the Fed to reduce interest rates by 25 basis points, in line with market expectations, at the next meeting scheduled for September. 

Mr Elston said the effects of inflation have yet to be felt on the US economy although in theory trade wars, such as the ongoing one between China and the US, should generate inflation due to manufacturers passing on increased import costs to consumers.

He said advisers could protect their clients by reducing exposure to equities, and looking for ‘bond proxies’.

“In some respects equities may be safer than bonds but I would certainly not suggest increasing an equity to bond portion to say 80-20 per cent. "

He said investors were unlikely to get the same returns generated by bond markets over the last 40 years but Mr Elston cited infrastructure as a good sector to invest in the near term. 

Each week, FTAdviser will be joined by a guest from the industry to discuss the week in news and pressing industry issues.