When the stock market dropped in mid-August, there was a lot of news about the Yield Curve. The weakness in August was triggered by two factors: the yield curve inverting, and some evidence that global growth is slowing.
What is the Yield Curve, and do I need to worry?
Think of the Yield Curve as a line graph showing several yields or interest rates across different time periods. Normally, as the time is lengthened, interest rates are higher, and the line curves up. When longer term rates are lower than short term rates, the line curves down.
The curve is a representation of investor expectations for inflation, economic growth and interest rates. With mid and longer end yields lower than those in the short end, investors are saying that they don't expect an increase in inflation, growth will be muted, and interest rates will decline. An inverted yield curve signals a potential recession, but it does not cause a recession.
In August 2019 the spread between the 2 year note and the 10 year note inverted for the first time since June 2007. The yield curve charting the spread between the 3 month note and 10 year note inverted in May 2019, and markets also dipped in that month. Historically, a recession begins 18 – 22 months after a yield curve inverts. Often an inverted yield curve signals investors to move towards defensive or less volatile investments.
Is Global Growth Slowing?
Global markets have been stimulated in recent years by lower interest rates. By easing financial conditions and lowering interest rates, a central bank can stimulate an economy by making business and consumer loans cheaper. The lower interest rate also depreciates the local currency, boosting exports.
However, central banks may be running out of room to use lower rates to stimulate growth, as rates are already low. Inflation pressure is weak, there is escalating US-China trade tension and increasing China-Hong Kong protests, all combining to boost demand for safe-haven bonds.
Remember, a yield curve is an indicator of investor sentiment – not fundamental data. China has shown a bit of weakness, and the latest data show that China’s lower exports to the United States have been offset by stronger exports to the rest of the world. The weakness in Europe is more pronounced, but by no means a collapse. The US economy continues to create jobs, even with the unemployment rate already at a 50-year low, employee wages and salaries are growing, household consumption rates are still healthy. In short: the economic data show no evidence that either the United States or the global economy is approaching a recession.
In July, Philip Petursson, Chief Investment Strategist at Manulife Investment Management shared his insights on where the equity and fixed income markets have been and where he believes they may be heading in the future.
- We are not calling for a recession but we are in a Global economic slowdown
- Stocks are neither cheap nor expensive, but earnings are questionable
- Bond markets and yield curves are saying interest rates could ease down
- The Canadian dollar is likely to be range-bound around US$0.775
- Reducing risk may be prudent in an uncertain environment.
We have positioned your portfolios based on what you have told us about your income needs, time horizon and risk tolerance; asset mix is slightly higher towards bonds vs past years. We believe a professionally managed, diversified portfolio that is suited to your time horizon and risk tolerance remains the best strategy for helping you achieve your financial goals.Please contact your Investment Advisor to ensure your portfolio remains suitable to your needs.
Elaine Kelly MBA CFP FCSI
Senior Investment Advisor, Manulife Securities Incorporated