As I write this on February 9, 2019, the yield curve has further flattened. The 3-month yield and the 3-year yield both currently stand at 2.43%.  The question is: why would someone lock in the same rate for 3 years as for 3 months?

When you buy a US Treasury bill, you are essentially locking up your money.  If you could collect the same exact interest rate, you would typically rather buy a 3-month bill over a 3-year bill.  You can keep rolling over your 3-month security while still having access to your money if needed.

The only reason to buy the 3-year instrument (the longer term) is that the rates might go lower. You want to lock in what you consider to be a high rate as compared to the future.

When longer-term rates fall below shorter-term rates (an inverted yield curve), this indicates some fear amongst bond investors.  They are locking in longer-term rates in anticipation of them dropping further. There is less demand for short-term securities.

In terms of the current yield curve, there is already a slight inversion between the 2-year and the 5-year.  There is just one basis point (0.01%) separating the 3-month yield and the 5-year yield.  Even the 1-month and 2-month yields are about equal.

The 10-year yield is still a bit higher.  There is a 20 basis point spread from the 3-month yield.  When looking for an accurate recession indicator, I like to compare the 10-year against the 3-month.

Surprisingly, Most People Don’t Even Pay Attention

The last few months of 2018 were brutal for U.S. stocks.  It had some investors worried.  Then things turned around in January as stocks soared.  I think it was relief to many investors who are heavy in stocks.  Despite the correction in late 2018, the downturn seemed to be put down, and stocks were heading up again.

However, we should ask, was late 2018 just a little blip down in a continued bull market? Or was January 2019 just a blip in the beginning of a new bear market in stocks?

I am tending to lean to the latter because of what the yield curve is telling us.  Despite the hot January for stocks, the yield curve didn’t steepen much.  Now it is slightly flatter than it was at the start of 2019.

I really think there is something to the fact that most analysts just don’t want to be too pessimistic.  I know there are some perma-bears out there who always think the sky is falling.  But if you look to the establishment financial media (just about anything you would see on television or read in a major newspaper), there is a heavy bias towards being bullish on stocks.  You may hear a few guests mention the yield curve, but most of the big players just ignore it.

It is incredibly hard to predict financial markets.  This is why most people don’t get rich by investing.  It is even harder to time markets.  Yet, the yield curve is the one indicator that seems to almost always be accurate.  When there is an inverted yield curve, it means a recession is coming, likely in 18 months or less.

The yield curve, as it stands right now, should really be the lead story almost every day on any financial network or website.  If you go to CNBC during trading hours, the yield curve should be the most discussed topic.  Instead, you get a lot of talk about management changes at particular companies and their revenue forecasts for the next quarter.  It is missing the big picture.

CNBC and other networks will discuss the Federal Reserve when there is a meeting on monetary policy.  This is big picture stuff, for sure.  But even with Fed meetings, sometimes I feel like the big points are being missed.  We hear a lot about the federal funds rate, but we hear less about the interest paid on bank reserves, which is controlling the federal funds rate.  We also tend to hear less about the Fed’s current policy of draining its balance sheet (monetary deflation).

Just because it is not being widely discussed, it doesn’t mean that the yield curve is not important.  I think it is the most important indicator out there right now.  It is telling us that the strong performance for stocks in January may not last long.

Unless the yield curve starts steepening again, it looks like an economic downturn is coming. Stock investors will be among the hardest hit.