Doom and gloom sell newspapers, so it’s no surprise that recent headlines were ringing the alarm that our economy was headed for a recession. What happened to cause the journalistic panic? The interest rate yield curve inverted for a brief period.
The yield curve is a graphical representation that shows the relationship between the short- and long-term interest rates of U.S. Treasury bonds. Under normal circumstances, bonds with longer maturities, such as the 10-year Treasury, typically carry higher interest rates than short-term bonds, such as the two-year Treasury. An inverted yield curve occurs when short-term interest rates exceed long-term rates.
With the Federal Reserve increasing the Federal Funds Rate, the rate at which banks lend on an overnight basis, in mid-March, the increase in short-term bonds was expected. With inflation at 7.9% as of February 2022, the Fed has indicated they are planning about six more rate increases throughout the year. When the 10-year Treasury interest rate is less than short-term rates, it indicates that near-term is riskier than the long term.
When interest rates rise, capital becomes more expensive for companies, which lowers the expectations for growth, eventually resulting in investors not receiving much growth from stock price appreciation. This can make stock ownership less desirable and, in some cases, more volatile. When investors view equities as too risky, they turn to dependable investments like Treasury bonds. However, as more investors rush to buy bonds, causing the yield to fall, it makes them a less attractive investment.
With stocks potentially having slower growth and bond yields falling because of demand, the yield curve tends to invert before a recession. We saw inversions before the recessions of 2000, 1991, and 1981. The yield curve also foreshadowed the beginning of the 2008-2009 recession. An inversion generally indicates a recession is coming; however, it could be within the next 12 months or perhaps take up to two years. The yield curve is only one of many economic indicators, among Gross Domestic Product, Employment Figures, Industrial Production, Consumer Spending, Inflation, Home Sales, Home Building, Construction Spending, Manufacturing Demand, and Retail Sales. Currently, unemployment has declined to 3.6%, a post-pandemic low; however, that can also contribute to higher inflation—which we have. Our current inflation has many catalysts, including supply chain issues, high demand from consumers who still have ample relief funds, and the war between Russia and Ukraine that is putting a strain on commodities like crude oil and wheat. Housing is strong, but retail sales are declining. All in all, the economy is a delicate balance between many factors.
As an investor, we recommend you ignore the noise. Instead of worrying and futilely trying to predict what the stock market will do next, construct your portfolio based on your individual long-term needs, not short-term market movements. The Henssler Ten Year Rule calls for you to put the money you need within the next 10 years into fixed-income investments held to maturity. In this environment, we generally keep maturities short, and hopefully reinvest at higher rates. Long-term money should be invested for growth, and we believe the stock market is the best place to achieve that growth. Your stock investments should be high-quality companies that can weather not only the next recession but also the next depression.
If you have questions on how to position your portfolio for our current economy, the experts at Henssler Financial will be glad to help:
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