What Do Yield Curve Inversions Really Tell Us?
While the previous four yield curve inversions have eventually been followed by a recession, the inversion-recession link is questionable.
Since April 1, 2022, the yield on the 2-year US Treasury has exceeded that of the 10-year Treasury. This so-called inverted yield curve shape, where longer-dated bonds yield less than shorter-dated bonds, is considered by some as a harbinger of economic recession. While the previous four inversions were eventually followed by a recession, the inversion-recession link is questionable.
For starters, it took between 272 and 486 trading days from the inversion onset for the recession to arrive. That’s about one to two years. To put that in perspective, the average US economic expansion has been about five years, which means the average waiting time for a recession, regardless of the rate environment, has been about 2.5 years. And in three of the four cases, the inversion was over before the recession began.
We also had one recession without a yield curve inversion—that was in 2020, occurring under circumstances we can fairly characterize as unrelated to past bond yields.
So, an inversion doesn’t really narrow down the timetable to an economic downturn. There’s also not much evidence inversions are cause for concern with investments. The stock market has posted substantial gains between inversion and recession in three out of four past cases—and is up double digits so far during the current inversion.
One of my favorite quotes from Nobel laureate Robert Merton is: “Just because people are talking about something doesn’t make it important.” People are talking about the current inversion because it hit 522 trading days as of April 30, making it the longest inversion yet without a recession. History suggests that doesn’t make it important for investment decisions.
EXHIBIT 1
Upside Down
US yield curve inversions, recession dates, and market performance as of April 30, 2024
INDEX DESCRIPTIONS
Fama/French Total US Market Research Index: July 1926–present: Fama/French Total US Market Research Factor + One-Month US Treasury Bills. Source: Kenneth R. French - Data Library (dartmouth.edu).
Results shown during periods prior to each index’s inception date do not represent actual returns of the respective index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains. Profitability is measured as operating income before depreciation and amortization minus interest expense scaled by book. Eugene Fama and Ken French are members of the Board of Directors of the general partner of, and provide consulting services to, Dimensional Fund Advisors LP.
DISCLOSURES
The information in this material is intended for the recipient’s background information and use only. It is provided in good faith and without any warranty or representation as to accuracy or completeness. Information and opinions presented in this material have been obtained or derived from sources believed by Dimensional to be reliable, and Dimensional has reasonable grounds to believe that all factual information herein is true as at the date of this material. It does not constitute investment advice, a recommendation, or an offer of any services or products for sale and is not intended to provide a sufficient basis on which to make an investment decision. Before acting on any information in this document, you should consider whether it is appropriate for your particular circumstances and, if appropriate, seek professional advice. It is the responsibility of any persons wishing to make a purchase to inform themselves of and observe all applicable laws and regulations. Unauthorized reproduction or transmission of this material is strictly prohibited. Dimensional accepts no responsibility for loss arising from the use of the information contained herein.
This material is not directed at any person in any jurisdiction where the availability of this material is prohibited or would subject Dimensional or its products or services to any registration, licensing, or other such legal requirements within the jurisdiction.
“Dimensional” refers to the Dimensional separate but affiliated entities generally, rather than to one particular entity. These entities are Dimensional Fund Advisors LP, Dimensional Fund Advisors Ltd., Dimensional Ireland Limited, DFA Australia Limited, Dimensional Fund Advisors Canada ULC, Dimensional Fund Advisors Pte. Ltd., Dimensional Japan Ltd., and Dimensional Hong Kong Limited. Dimensional Hong Kong Limited is licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities) regulated activities only and does not provide asset management services.
RISKS
Investments involve risks. The investment return and principal value of an investment may fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original value. Past performance is not a guarantee of future results. There is no guarantee strategies will be successful.
CANADA
These materials have been prepared by Dimensional Fund Advisors Canada ULC. The other Dimensional entities referenced herein are not registered resident investment fund managers or portfolio managers in Canada.
This material is not intended for Quebec residents.
Commissions, trailing commissions, management fees, and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Unless otherwise noted, any indicated total rates of return reflect the historical annual compounded total returns, including changes in share or unit value and reinvestment of all dividends or other distributions, and do not take into account sales, redemption, distribution, or optional charges or income taxes payable by any security holder that would have reduced returns. Mutual funds are not guaranteed, their values change frequently, and past performance may not be repeated.
Resources
