The Yield Curve Inverted

But that might not be reason to panic.


There has been reason for pessimism in markets recently. Last week, the Fed issued unexpectedly dovish rates guidance, saying it would likely not hike interest rates this year. Weak economic and manufacturing data out of Europe stoked concerns about the health of the eurozone. And on Friday, for the first time since 2007, the yield curve inverted, meaning the yield on the US 10-year Treasury note fell below that for the 3-year note. It’s a sign that investors are concerned about the short-term outlook. And in the past, an inversion of the curve has been a reliable recession predictor.

Accordingly, analysts attributed the ensuing bloodletting in stock markets worldwide in part to fear about a US recession. Predata signals, however, indicate that in this case markets may be overreacting to the implications of the yield curve inversion. For one, online concern over a US stock market bubble has barely budged, remaining within its normal range for 2019. Traffic on pages related to past stock market crashes is less than half as high as it was from September-October 2018, when the S&P slid nearly 10% over six weeks.


Instead, market concern is focused more specifically on sectors that would be highly exposed in the event of a potential Fed rate cut by 2020, such as housing. Such activity makes sense given the Fed's recent dovishness.


The narrow scope of the concern over the immediate health of the US economy implies that markets are looking to looming risks in Europe and Asia -- such as slowing growth in China and underlying weakness in the eurozone -- as sources of a potential global slowdown. For example, Predata signals that capture concern over certain aspects of financial risk in China have been particularly active in 2019.


But unless those risks materialize, global stocks may well reverse their recent losses.