2's 10's INVERSION - THE TRUTH

😲 2's 10's INVERSION😲

A journalist's favourite recession indicator, the “2’s 10’s curve” inverted earlier this month… As the story goes, 𝙩𝙝𝙞𝙨 𝙡𝙚𝙖𝙙𝙨 𝙩𝙤 𝙖 𝙧𝙚𝙘𝙚𝙨𝙨𝙞𝙤𝙣 within 12-24months 😲

👉 But this time… it’s different 😅

Here’s the chart -> (FRED-FRED:T10Y2Y)

To clarify, I’m not saying there won’t be a recession, or NSDQ100 crash, in fact it’s a real possibility. But the 2’s 10’s chart is not a good indicator to rely on.

WHAT IS THE YEILD CURVE ⤴

The yield curve is just a curve plotted on a graph of the interest paid on debt.

The X-axis being the duration of the debt (e.g. a 2yr loan and 3yr loan etc.) and the Y-axis being the interest (e.g. 1%, 2%, 3% etc.).

2️⃣ - 2’s is shorthand for the 2 year US Treasury Note (a 2 year loan to the US gov.)
🔟 - 10’s is shorthand for the 10 year US Treasury Note.

🤔 HOW STRANGE

It’s an odd phenomenon that a shorter term loan could pay higher interest than a longer term loan - because why would someone want to lend money for a longer time at a lower interest rate 🤷

But this - otherwise accurate signal for a recession - is no longer credible as a market indicator.

Currently the yield curve is (heavily) distorted, with central banks around the world purchasing their own bonds (treasury notes). On top of that the FED has clearly stated they expect the funding rate to get to about 3% in 2023 - but expects a long term rate of 2.5%. So the FED is indicating intentional inversion.

It’s possible the yield curve could continue flattening or inverting, further fuelling these “recession imminent” articles. It's good to remember a small inversion is not a concern in this case.

There are clear signals of what will trigger a recession, I'll cover those in a future post. (remember to add me to a Watchlist to be notified)

HOW COULD YOU TRADE THIS

You could short the SHY and go long IEF or TLT to take advantage of the curve normalising over time.

In fact, from here, the IEF looks good even without the SHY short position (saving fees and keeping capital free)