Since April 1, 2022 the yield on the two year treasury has exceeded the yield on the ten year treasury. This so called inverted yield curve, when longer bonds yield less than short bonds, has been a harbinger of economic recession in the past. It’s not an exact science, but the previous four inversions were followed by recession. The timing is what is unknown about the link between the inversion and subsequent recession. It has been 570 trading days now since this recent inversion, the most in history without a recession. It is now ‘accepted wisdom’ that the recession will not start until the inversion normalizes, for lack of a better way to phrase it. The Federal Reserve has been talking rate cuts now for many months and September looks like the first quarter point cut we will see. This will make it likely that the ‘re-inversion’ is close at hand as the a Fed cut affects the short rates on the curve. A Kamala Harris victory in November will also potentially lead the economy towards a slowdown as the Trump tax cuts will most likely expire under a Harris administration and higher taxes will have a dampening effect on growth. As always, the key statistic regarding economic malaise will be the ongoing inflation reads. It was tricky on the way up for the Fed and it will be trickier on the way down. There is no play book for potential outcomes because we have never been here before, that is, a combination of sticky
inflation while lowering interest rates and shrinking the Fed’s balance sheet of the massive amount of bonds they bought during the quantitative easing of the post pandemic era. Of course a Trump victory brings a host of issues with it as well pertaining to potential inflation from trade tariffs and a continued ballooning of the deficit from increased potential tax cuts.

What can markets expect? The past inversions have not really affected equity investor returns. In three out of four past inversions the market posted substantial gains between inversion and recession. There is no predictable pattern. What happens once (if) the recession hits? Again, it is a mixed bag. What is a problem
this time though is the fact that the market is drifting along at all time highs and has not had a meaningful correction in several years now. Typically the market, being a leading indicator, will bottom before the recession even hits Main Street. The longer this goes on without a meaningful correction and the bigger the balloon gets …. well, nobody will give a damn about the yield curve inversion I guarantee you that. I know, why even think the market could drop when the party lights are on? There are some truly amazing technologies at hand right now from miracle weight loss drugs to Al. The hype is warranted … but oh my, the valuations of many of the stocks are sky high. Markets are starting to have a little bit of that 1999 feel at this moment. Enjoy the moment but be mindful of the old saw regarding buying an umbrella when the sun is shining.

Perhaps the recession talk is wasted air and the Fed will engineer the perfect soft landing, ala Simone Biles exiting the balance beam. And, perhaps recession will not be the boogie man that knocks this market off its peak at all but something else … the upcoming elections or maybe the rising tensions in the Middle East-China-RussiaNorth Korea? Fuhgettaboutit!! For now the blinders are on and big tech solves all the world’s problems in US investor’s minds as it’s up, up and awaaa-ay, in my beautiful, my beautiful ba-looooon!

By Rylie Nugent

Published September 23, 2024

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