Most of the time, longer dated bonds yield more than shorter dated bonds, as compensation for their greater risk. Occasionally this configuration reverses. And investors take note, because it’s one of the most reliable omens of deflationary episodes, including falling stock prices. The last significant inversion occurred in 2019, for example, prefiguring the stock price collapse of the spring of 2020. Though it may be tempting to dismiss that as exceptional due to the outbreak of Covid 19, a better interpretation is that a deflationary squall was on the way anyway. This recalls the stock market decline circa 09-11, which at the time was chalked up to the terrorist attacks, but which is actually quite difficult to pick out on a chart of the stock market, as it appears as just another of a series of drops as the market did its 2 1/2 year impression of a ball bouncing down the stairs.
In fact, yield curve inversions occurred before both of these episodes, as well as several others over the decades that had no extra-economic drama associated therewith, 2008 included.
The current yield curve inversion is unlikely to be any different, especially since it is now the broadest and deepest in four decades.
As of yesterday, the one year yield was 4.76%, versus a ten year at 3.69%, a deep 107 bp inversion. The inversion is exceptionally broad as well, with the three month at 4.41% versus 3.74% all the way out at thirty years.
The high water market for yield, and the price low, for five year maturities occurred on October 20, with ten, twenty and thirty year yields peaking on October 24.
Lead times vary, but the shape of the shorter end of the curve yields some hints. The exercise is complicated by Fed “forward guidance” efforts because they also shape the shorter end of the curve, but the more imminent signal arises not when short rates rise, but when they start to fall … the market adage “buy the rumor sell the news” is apropos … the Fed cut all the way through the last two major stock bear markets. Regardless, a broad inference that 2023 is shaping up to be decidedly deflationary is far from unjustified.