What Will Happen To Bond Funds When The US Yield Curve Inverts? – Mike Swanson (08/27/2018)

The global yield curve inverted on the week of June 11.  If you look at the charts you’ll see that the most recent drop in gold began during that week.

And this is the same week that emerging markets turned down and so did several key commodity indices.

An inverted yield curve is the most accurate forecaster of a recession and is caused when long-term interest rates fall below short-term rates.  When it inverts a recession begins 6-12 months later.

The global yield curve does not include in it the US yield curve, which is not inverted.

So the global economy is slowing and the US economy is still posting good headline economic news.

This explains the US dollar rally that has hurt gold.

But the US yield curve has been flattening all year and is on track to invert too by the end of the year.  Check out this chart of the spread between two-year and ten-year Treasury bonds.  When it goes below zero it means that the yield curve is inverted.

After the yield curve inverts is historically when the Federal Reserve stops raising rates during a cycle of interest rate hikes.  Then they can pause for as long as they can until the economy tips into recession.  Then they begin to lower rates.

The Federal Reserve just follows the bond markets.

Here is what you need to know.

When a yield curve flattens and inverts typically long-term yields continue to decline.  Since bond prices (and funds) move opposite to their yields this means that you can expect bond prices to go up.

Take a look at this chart with the yield curve on top and the ten-year bond yield below it.  You can see that when the yield curve inverts the long-term yields then simply continue lower and lower.

We saw a pullback in bond prices earlier this year that sent the 10-year Treasury bond yield briefly over 3.0%.

It’s currently sitting at 2.82%.

The fact that the yield curve is heading towards inversion tells me that we now have a powerful resistance for ten-year bond yields this year right above 3% and that the next real big long-lasting move will be for lower yields.

Yes, bonds are the biggest bubble in human history, but we are not at the stage in which the US government bond market is going to go into a big bear market.

We’re going to have one more move cycle higher first for bond prices and drop in bond yield down towards the lows of 2016 in the next 1-3 years.

Perhaps the cycle AFTER that move will be the big bear one.

Right now though as investors this means that US bonds are still going to act as a safe haven during times of financial turmoil overseas and even economic weakness in the US.

The flattening yield curve also tells us that we are LATE in this economic expansion cycle and US stock bull market, but have not seen the end of either yet, although we are seeing many stock sectors complete stage three tops and cracks of weakness inside the US stock market.

Overseas the picture is much worse though and when the yield curve forecasts falling long-term interest rates for the future it also means it does not see any real threat of inflation.

As for gold – we saw the start of huge bull moves in gold and mining stocks occur the last two times the yield curve inverted.

In the year 2000 gold stock fell and fell after the yield curve inverted and then turned up in the Fall of that year to go up for years.

In 2006 the yield curve inverted and gold stocks paused within a big bull trend and then exploded higher by September of 2007 as the Fed made its first emergency move (that’s when Cramer yelled for help on CNBC).

Those moves though started after the yield curve inversion and not before it so this is something to consider now.

The simplest thing you can take from this is that US treasury bonds are still a safe place to have some money in these markets – and are even likely to go higher over the next twelve months.

We are only one or two more rate hikes away from the Federal Reserve’s last hike for this cycle.

Here is the TLT ETF for the 20-year US Treasury bond.

It’s been basing in a range all year and is likely to break to the upside before the end of the year.

 

 



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