Weighing the Impact of the Yield Curve Inversion
By Michael Mullaney
Director of Global Markets Research
A new obstacle for the economy/market presented itself on March 22, when the yield differential between 3-month Treasury Bills and 10-Year Treasury Bonds inverted for the first time since August 2007. Given that an inverted yield curve has preceded each of the past eleven recessions, the S&P reacted by dropping by -1.9%, the worst daily performance for the stock market (and the best daily performance for bonds) since January 3, of this year.
In the ensuing trading sessions, the negative reaction to the yield curve inversion was largely offset by a surprise move by the Federal Open Market Committee (FOMC), which lowered the “dot plot” rate projections below expectations at its March meeting. Subsequently, dovish commentary from Chairman Jerome Powell and other committee members confirmed that the Federal Reserve did not anticipate any additional rate hikes during 2019. This was taken by investors to mean that a “Powell Put” for the stock market was now in place. And Fed Fund futures also began to price in the likelihood of a rate cut by the end of 2019. By the end of March, the yield curve had unwound the inversion.
While an inversion of the yield curve has been a reliable indicator of an impending recession historically, the timing of the onset has varied greatly, from a low of nine months to as high as twenty-three months over the last five recessions. There are also a host of other factors that are affecting the shape of the yield curve today: from a highly unusual negative U.S. term premium to the $10 trillion of global sovereign bonds carrying negative interest rates. Taken together, these scenarios can act as an anchor to U.S. bond yields.
With a gain of 1.94% in March the S&P 500 vaulted to a 13.65% return for the first quarter of the year, offsetting the -13.52% loss recorded during the final quarter of 2018 and posting the highest quarterly return for the index since Q3 2009 and its best first quarter return since 1998. The gains were spurred in part by: central bank monetary policy reversals, progress on China/U.S. trade negotiations, and evidence of “green shoots” emerging for the Chinese economy. Seasonal patterns would seem to bode well for the U.S. stock market. On average, April has produced the highest monthly return for stocks over the last 50 years. With Q1, 2019 S&P earnings projected to fall by -1.5% on a year-over-year basis (the first drop since 2016), it remains to be seen if the pattern can be repeated. Food for thought: since 1950 there have been 10 first quarters in which stocks gained more than 10%; in seven of those instances, stocks went on to post positive returns for the second quarter, and in nine instances, stocks also showed a gain for the remaining three quarters of the year.
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Boston Partners Global Investors, Inc. (“Boston Partners”) is an investment adviser registered with the SEC under the Investment Advisers Act of 1940. The views expressed in this commentary reflect those of the author as of the date of this commentary. Any such views are subject to change at any time based on market and other conditions and Boston Partners disclaims any responsibility to update such views. Past performance is not an indication of future results. Discussions of securities, market returns and trends are not intended to be a forecast of future events or returns.