The US yield curve has now returned to a normal shape after being inverted since 2022. But what does this mean?
When the yield curve is inverted, it means that short-term interest rates are trading higher than long-term interest rates. Usually, the 2-year and 10-year interest rates are referred to when talking about the yield curve. Short-term interest rates are mainly influenced by central banks' monetary policy, while longer-term interest rates are driven by market expectations for growth and inflation.
A return to a normal yield curve, where short-term rates are lower than long-term rates, is neither bullish nor bearish for the stock market in itself. It must be interpreted in context with other economic signals.
Bullish signal: A return to normality could signal that investors expect an improvement in economic conditions, with long-term growth prospects rising relative to short-term risks. If the disinversion is accompanied by falling short-term interest rates, it could indicate that the Federal Reserve is shifting to a more expansionary monetary policy (such as cutting interest rates), which could be positive for stocks.
Bearish signal: A return to normal can occur before or during a recession, which tends to be bearish for the stock market. Even if the curve returns to a normal slope, the inversion could signal that a recession is imminent or already underway. If the Fed cuts interest rates in response to economic uncertainty, it is a negative signal. A 50 basis point cut could lead to increased anxiety in the stock market.
Below we see statistics on major markets after the yield curve returned to normal.
Overall, a return to a normal yield curve is neither unambiguously positive (bullish) nor negative (bearish). As with so many things, it depends on several factors. The yield curve will be a hotly debated topic, but it is a typical macro signal that we should not rely too much on.
Predicting a recession is difficult and can easily lead to misjudgments. Even if you are right, it can be difficult to pinpoint the right time. The most important question is how deep a possible recession will be, but neither macroeconomic indicators nor technical analysis can provide a sure answer to that question, as the outcome depends on future events and market reflexivity.
After studying at Uppsala University, Erik Hansén has worked in the financial industry since 2007 at several brokerage firms and traded privately. In his role as an analyst, Erik has written highly regarded market letters.
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Return to a normal yield curve
Posted by Erik Martin Hansén
Post date 09/09/2024 Reading time - 2 min readThe US yield curve has now returned to a normal shape after being inverted since 2022. But what does this mean?
When the yield curve is inverted, it means that short-term interest rates are trading higher than long-term interest rates. Usually, the 2-year and 10-year interest rates are referred to when talking about the yield curve. Short-term interest rates are mainly influenced by central banks' monetary policy, while longer-term interest rates are driven by market expectations for growth and inflation.
Bullish signal: A return to normality could signal that investors expect an improvement in economic conditions, with long-term growth prospects rising relative to short-term risks. If the disinversion is accompanied by falling short-term interest rates, it could indicate that the Federal Reserve is shifting to a more expansionary monetary policy (such as cutting interest rates), which could be positive for stocks.
Bearish signal: A return to normal can occur before or during a recession, which tends to be bearish for the stock market. Even if the curve returns to a normal slope, the inversion could signal that a recession is imminent or already underway. If the Fed cuts interest rates in response to economic uncertainty, it is a negative signal. A 50 basis point cut could lead to increased anxiety in the stock market.
Below we see statistics on major markets after the yield curve returned to normal.
Predicting a recession is difficult and can easily lead to misjudgments. Even if you are right, it can be difficult to pinpoint the right time. The most important question is how deep a possible recession will be, but neither macroeconomic indicators nor technical analysis can provide a sure answer to that question, as the outcome depends on future events and market reflexivity.