We likely avoided a full yield-curve inversion

In our early June post “Is the U.S Yield Curve Inversion locked in?” we mused that only portions of the term-spread complex had inverted and most likely would remain that way, allowing us to avoid a full scale term-spread inversion. As the chart below shows, this is indeed the case – with only 50% of the term-spread complex having inverted as of 26 July 2019 and a maximum of only 60% of the term-spreads having inverted so far:

Literally all 10 of the term-spreads seem to be rising now. Furthermore, the average of all 10 term-spreads, our preferred term-spread metric, has inverted only briefly for a 1-week and 2 week spell and also seems to be trending upwards away from inversion.

Our message remains that focusing on (1) the percentage of term-spreads that have inverted together with (2) the average yield of all term spreads together, is a more robust mechanism of evaluating the term spread structure for recession risk. In this respect, the following two conditions need to both be present before proclaiming a full-blown yield curve inversion:

  1. The average yield of all 10 term-spreads need to be negative for at least 4 consecutive weeks
  2. At least 7 of the 10 term-spreads need to be inverted (70%)

The historical deployment of these conditions can be examined on the chart below:

It is not outside the realms of possibility that we are witnessing a similar false positive to that of 1998, and dare we say it, but perhaps the U.S economy is in for a soft landing? If this is indeed the case then all we have to be really concerned about is the current dangerously high (subscription required to open) stock market valuations.

It is going to be interesting to see the reaction of all these term spreads to a looming Fed rate-cut. Conventional wisdom is that they will all move even further away from inversion.

About RecessionALERT

Dwaine has a Bachelor of Science (BSc Hons) university degree majoring in computer science, math & statistics and is a full-time trader and investor. His passion for numbers and keen research & analytic ability has helped grow RecessionALERT into a company used by hundreds of hedge funds, brokerage firms and financial advisers around the world.

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