Last week, the US and UK yield curves briefly inverted for the first time since 2007 and 2008 respectively, meaning that the yields offered on 10-year government bonds were lower than those offered on 2-year government bonds.
While it is true to say that every recession has been preceded by an inversion of the yield curve, it is also true that not all inversions have led to recessions. That aside, we are tempted to say that this time it is different. Famously the most dangerous words in investing but fitting, we think, at least as far as this latest US inversion is concerned.
Typically, yield curves invert because shorter-term yields spike due to central bank action to choke off inflation, while longer-term rates stay relatively stable. This time both US 2-year yields and US 10-year yields fell sharply, with the latter outpacing the former on the way down.
This suggests the prevailing narrative of concern over imminent recession may not necessarily be investors' main motive, and that they may be acting in anticipation of further stimulus measures across the globe. After all, equity markets are only a few percent away from their all-time highs.
There are also structural issues at play that have been affecting yields more broadly in recent times, for example quantitative easing, regulation, and ageing demographics.
A whole new world
Today, yields are as low as they have ever been. The 30-year US Treasury yield dipped below 2% for the first time in history on 15 August 2019, and a significant proportion of global debt now exhibits a negative yield, something unheard of a decade ago.
This trend seems to have accelerated in 2019, with the amount of negative-yielding debt more than doubling to nearly $17trn. Negative yielding corporate debt now amounts to more than a trillion dollars.
One chart that crossed the desk last week highlighted just how extreme things have become, and that was the spread between the 60-year Euro interest rate swap and six-month Euribor.
Undoubtedly there is a very different supply and demand dynamic at play in bond markets today, one that has skewed the market to extreme levels.