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The Treasury Yield Has Inverted This Week—A Recession Is Coming

Dec 04, 2018 | Peter Christensen |

The Treasury Yield Has Inverted This Week—A Recession Is Coming

When the US government borrows money, the interest it pays is called the Treasury yield. The Treasury yield tells us how much the government is paying to borrow money, and how much investors earn through their investments in that government debt. The Treasury yield influences the interest rates that businesses and individuals pay for loans towards, equipment, property, vehicles, etc. The rational is simple. If the US government is willing to pay x% in interest, than a business or an individual that does not have the same power and credit as our country will need to pay more.

The US government is in charge of huge projects across the country, such as infrastructure. To raise capital for those projects, it issues debt instruments through the US Treasury. Depending on the scope of the project, it can issue Treasury bills (T-bills), which are short-term bonds that mature within 12 months; Treasury notes, which run up to 10 years; or Treasury bonds (T-bonds), which mature in 20 or 30 years.

Treasury terms and yields

Normally, longer-term Treasuries have a higher yield than shorter-term Treasuries. For instance, a 20- year bond would have a higher yield than a 5-year bond. The reason behind this is a combination of positive expectations about growth and inflation, and the assumption that more adverse economic events are more likely to take place over a longer period. The risk is higher for long-term Treasuries, so investors are compensated through higher yields.

If, however, investors expect problems in the economy in the short term, the demand for short-term Treasuries will drop. Investors will sell them off faster than longer-term Treasuries because they foresee slower short-term growth. As a result, the yields on short-term securities increase. These yields may exceed long-term yields, and if that happens, we experience what is called an adverse credit event. Generally, this causes the yield curve to flatten or even invert. Such a situation is a sign that we are headed towards a recession.

A recession is coming

And we saw that sign on Monday, Dec. 3, when the US Treasury yield curve inverted for the first time since 2007. The 5-year Treasury yield fell below the yield on the 3-year note, which means that investors were being paid more to hold US government debt maturing in 3 years than bonds maturing in 5 years.

Analysts, including Ian Lyngen, head of united rates strategy at BMO Capital Markets, are predicting that we are headed towards a situation where the 2-year note holds a higher yield than the 10-year note. On Monday, the spread between the 2-year note and the 10-year narrowed to 0.16 percentage point, its flattest levels since July 2007.

This is a situation that has preceded every US recession since World War II, including the recessions of 1981, 1991, 2000, and 2008. Prepare yourself and your finances for a recession by diversifying your portfolio with gold and silver. Following the last financial crisis and recession, the gold price tripled in value, and silver quintupled. The time to diversify is now.