What Wall Street Gets Wrong About the Inverted Yield Curve

Keith Fitz-Gerald

Things that'll be "different this time" usually aren't, especially when it comes to hot stoves, hot steering wheels, and hot bond markets. Touch 'em and you'll get burned, or so goes the thinking.

Every once in a while, though, the situation plays out.

Take the inverted yield curve that caused last Friday's vicious selloff and made countless headlines around the world when it happened for the first time since 2007.

Contrary to what Wall Street and legions of economists want you to believe, it may NOT be the harbinger of doom that it's been for the past 50 years.

Here's my case (and what to buy if you're interested in big profits).

An Outdated Predictor

First, let's set the stage.

If you've never heard of an "inverted yield curve" or you're uncertain exactly what one is, you're not alone. In fact, I know a lot of professionals who can't explain yield curves properly.

What you need to understand is actually pretty simple.

The "yield curve" is a very specialized economic indicator based on the comparison between short-term risks and longer-term risks, as reflected by the rates of return associated with them over time.

Normally, there's an upward slope because longer-term investments are riskier than shorter-term investments, because of the time involved so your required rate of return is higher. But every once in a while, the curve "inverts" – meaning that short-term risks become higher than longer-term risks.

When that happens like it did last Friday, the "curve" goes from this…

To this…

Now, here's the part that will get me uninvited from every Wall Street cocktail party for the next 200 years… yield curves have zero predictive capacity whatsoever.

Financial heresy?

Not really. Yield curves simply show you what the market thinks about how inflation is being managed and where interest rates are headed.

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The other thing to think about is that there are lots of curves, not just one. So blanket statements like there's been "an inverted yield curve today" really don't amount to a hill of beans.

For instance, you can construct a yield curve of 3-month treasury bills and 10-year notes, or 10-year notes and 30-year notes. You can even construct cross-currency curves to compare rates in different countries or regions as a means of assessing economic prospects around the world

The most popular curve – and the most widely reported – is the 2-year versus 10-year which hasn't yet inverted but is very close, as I type. Last week's inversion, in fact, was actually between the 3-month rates and 10-year yields.

What does that tell you?

Again, not much.

It's circumstantial evidence at best. If anything, the yield curve is merely flattening and – ta da – the markets can have plenty of positive performance with a "flat" yield curve – meaning long and short term rates are nearly equal.

Which brings me back to where we started.

Now, Why You SHOULDN'T Worry About The Inverted Yield Curve

Keith Fitz-Gerald

About the Author

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Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs High Velocity Profits, which aims to get in, target gains, and get out clean, and he's also the founding editor of Straight Line Profits, a service devoted to revealing the "dark side" of Wall Street... In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.

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