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An inversion of the US yield curve, where the 10-year bond yield falls below the 2-year bond yield, has typically been seen as a market indicator of a pending recession. It has a pretty good track record of occurring before recessions, albeit with an inconsistent lead time. Inverted yield curves have typically normalised when rates at the front end of the curve have fallen because the US Federal Reserve has been cutting policy rates. As shown below in our Chart of the week, the US yield curve has also historically normalised ahead of recession onset (according to official statistics, dated with hindsight). While we haven’t had a recession since the most recent curve inversion, it does not appear that the US is facing an imminent recession even as the Federal Reserve is on the cusp of easing policy rates. For us, the more important issue is if the curve moves have predictive capacity for market moves. There’s a limited data set, but historic stock market returns after a curve inversion or normalisation have been somewhat inconsistent (in the short term they have been slightly better after the inversion than after normalisation). So, it appears there are other significant factors at play. In our view, near trend economic growth rates, slowing inflation and easing monetary policy should be a supportive backdrop for earnings growth and risk assets. Still, the broader macro picture is more mid-to late-cycle than early, so we prefer secular/defensive growth equities over the most cyclical sectors.
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