The spread between the 10-year and 2-year yields recently un-inverted. While this made headlines across financial media, many investors were left wondering what this actually means for the stock market and economy.
An inverted yield spread occurs when short-term Treasurys are yielding more than long-term Treasurys and arises when investors are pessimistic about future economic conditions. Inversion for prolonged periods has historically been one of the most reliable recession indicators, with a 100% accurate track record.
More importantly, the un-inversion (red circles on graph below) usually signifies an impending recession, as an economic slowdown comes closer into view and investors start betting on aggressive rate cuts from the Federal Reserve. Lead times vary, but in virtually all cases, it has ended in recession.
While many continue to believe that the Fed can pull off a soft landing, investors betting against these historical odds should tread carefully. With the current weight of evidence and possibility of a hard landing ahead, we will continue to proceed with caution and maintain our defensive positioning.
