What is a treasury yield curve, and why are the financial media suddenly talking a lot about it?
What is a Yield Curve
A yield curve is the graph of the returns on a piece of debt. In the US, we refer to these as treasuries because they are issued by the US Treasury Department. A 10 year yield curve will show you the amount of return one would expect to get on a 10 year dated treasury over time. The yield rates change as factors in the economy either get better or worse.
Tough economic times usually see a higher yield to compensate buyers for holding debt from the Treasury department. When the economy is stronger and we see growth from year to year, bond investors are more likely to believe in the ability of the government to pay back the debt. Therefore, yields will fall.
Bond holders are typically very smart and often see problems brewing in the economy much faster than stock investors. While stock investors may be focused on one company, an industry, or a collection of different firms, they often ignore some or much of the economic data that bond holders pay attention to. Think of bond holders as macro-economists focused on the broad economy, whole stock holders are typically looking for returns on individual investment ideas using micro-economic factors.
The treasury yield curve is also key indicator of an oncoming recession in America, because bond holders really pay attention to the economic data and make their investment decisions accordingly. When comparing yields of shorter and longer term treasuries, the difference can be used to measure near term risk in the market.
Let’s suppose bond investors who buy 10 year treasuries want to be compensated for giving up their cash for a decade. They would expect more return, because we have less idea about what could go wrong over 10 years than we do tomorrow. And at the opposite, end, investors putting money into 2 year treasuries have more confidence over the risks in the next two years. Thus, the longer the term of the bond, the more return, or yield, investors want.
What happens when shorter term treasuries have higher yields? This means investors actually expect more risk now than they do in the future. When this happens, the market is typically very unstable and investors are telling us that they expect a contraction or even a recession. The act of short term treasury interest rates eclipsing longer term rates is called a yield curve inversion. And 7 out of 8 times it has happened in US history, a recession followed shortly thereafter.
I have written about yield curve inversion events in prior articles. Last year, we saw the world yield curve invert. That means the average returns on 10 year debt across the world had less return than the 2 year. And at the same time I pointed out why Europe and China economies are in a recession.
This week we saw the 10 year and 3 month US treasury yield curves invert for the second time in 2019. This is a clear indication that bond investors see a lot of risk in the economy, and expect an event in the near future.
The fact that investors of 2 year treasury paper have not demanded higher yields yet is very interesting. However, by looking at the 10 & 2 year rate chart provided by the Federal Reserve, we can see the yield curves of both are nearly touching each other. I fully expect these two curves to invert in the near future, perhaps in the second half of 2019.
How Much Time Do We Have
That depends on the depth of the recession. Typically you have about 6 months or so after a yield curve inversion before the economy is officially pronounced in a recession. However, that pronouncement takes a quarter or two of data before government officials will proclaim it. You could be seriously affected as soon as the yield curve inverts, because the recession may have actually started by then. And in many cases, people have lost their jobs before governments officially call economic recessions.
What You Should Expect
What do we do when the 10/2 yield curve finally inverts? Well, that is basically your last early-warning sign that a recession is headed our way. This means planning for the recession by doing the following things:
- Saving as much extra cash as possible
- Taking that cash outside of the banking system
- Pay off as much short term debt as possible, such as credit cards
- Putting off vacations and any other large purchases that you don’t need
- Increase your stores of food and other shelf-stable items
- Cut any unnecessary monthly payments, such as cable TV and subscriptions
- Take any extra training at work to make yourself more valuable than the next person to your employer
- Reduce your risk in the bond and equity markets
- Purchase some precious metals as market crash insurance
You may lose your job, and her is why. Large companies have begun to lay off workers by the thousands. These companies are already struggling to grow and make profits, and therefore have to cut costs. Labor is usually one of the largest and first costs cut during a downturn. That is why it is suggested to make yourself as valuable as possible as you can to your boss. You want them to avoid picking you for the employment line because they cannot meet their goals without you doing your job.
Companies are also taking on a lot of debt and buying back stock. They typically do this when stock is expensive. It strengthens short term returns and also allows insiders to sell out of most of their overpriced stock they received in their compensation packages. But this often leads to a lot of pain for stock holders later on as their share prices crash during a recession, and they held on too long. That is why you don’t want to be holding a lot of stocks or bonds during a recession, as both of them can be discounted by a lot just when you may need them most to meet your bills.
Many people will be laid off and take large losses in their investments at the same time. This is a double whammy that causes many people to take money from the government. Some people lose their homes and end up at shelters, taking whatever is given to them. By properly budgeting ahead of time, you may avoid this type of disastrous scenario even if you are not able to hold on to your job.
Banking Sector Problems
When the inevitable happens, expect things to escalate in the financial markets quickly. You will begin hearing more negative press on the bond markets. The fear building in these markets will also panic stock investors, and asset prices across the board are likely to fall. Also, expect to hear trouble with the banking sector. All of those losses in bonds and stocks will tank the portfolios of banks and make many of them insolvent. This means they will not be able to pay their bills, and will ask for help from the government.
Given the fact that the government is in dire straits already, they will be able to do much less this time than they did during the last recession. Their main choices will be to print more money and cut services. Cutting services to the needy and poor will be disastrous to an already stressed populace. This will lead to riots and social disorder. The government will be force to issue more debt and print money, and other nations are not likely to finance the spending this time. This will probably lead to the final failure of the US dollar as a currency.
Get Started Now
If you are reading this article, you still have time to make some preparations. You may not be able to pay off your home and get completely debt free. You do have time to do many other things; however, to minimize the amount of damage you suffer when a recession hits. Given how close the final 10 & 2 year yield curves are, it should not take long for the final inversion to take place.
Gold and silver can help you survive currency collapse brought on by the next recession, which will be both nasty and global. And when the recession happens, gold and silver will be extremely hard to find. So you want to purchase enough now that you are not left without when the crash comes.