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Street Signs: Dangerous Curve Ahead

February 21, 2020

The relationship between long-term interest rates and short-term interest rates is known as the yield curve. Normally rational investors typically demand a higher rate of return to lock up their money for the long-run. However, sometimes these rational investors do something very strange; they accept a lower interest rate for long-term bonds than they do for short-term bonds. When long-term bonds are paying less than short term bonds the yield curve is said to be “inverted.”

Why would they do this? And what does it mean? That’s the subject of today’s Street Sign: Trouble with the (yield) curve. In a way short-term interest rates represent the price of money. They are higher when there is a higher demand for money. And this makes sense. Imagine two businesses looking to expand and competing with each other for a new loan.  This allows their banker to charge a higher rate. Moreover, how does the banker lend to both?  The banker must gather more deposits to allow them to make more loans. How do they gather more deposits?  They offer to pay depositors a higher rate of interest!

It may also be helpful to think of long-term interest rates as something approximating the sum of all the expected short-term interest rates between today and some future day. This is why an inverted yield curve is so important. It is telling you that, despite the fact that things appear good today, investors don’t see that continuing much longer.

Indeed, the yield curve is one of the best recession indicators we track – and it is currently warning of possible danger ahead. The yield curve has inverted only 11 times since 1955. 10 of those 11 were followed by the onset of a recession in 6-16 months.

For the first time in nearly 12 years, the yield curve inverted in May of 2019. The clock is ticking.

What does Deupree James suggest?

Our goal is to help you make wise financial decisions. We caution anyone against basing an investment decision off one factor – especially one with such a small sample size. However, a slowing economy has typically been better for bonds and gold than for stocks. Within the stock market, utilities, health care, and real estate typically hold up best during a slow-down.  Deupree James has been making similar adjustments to our client portfolios for a month now.

 

The information contained herein is for informational purposes only, is not personalized investment advice and should not be construed as a recommendation to purchase or sell any particular security, sector or strategy to any individual person or entity. The decision to review or consider the purchase or sell of any security, sector or strategy mentioned should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional. Past performance should not be considered as an indicator of future resultsSecurities offered through Triad Advisors, LLC. Member FINRA/SIPC. Investment advice offered through Goss Advisors, a registered investment adviser. Goss Advisors and Deupree James Wealth Management are separate entities from Triad Advisors, LLC.