Take Advantage of the Inverted Yield
By now, you’ve probably heard about the inverted Treasury yield. It’s hard not to notice when the news is splashed all over headlines.
It’s interpreted as a bad sign for the economy because it means bond investors think a recession is coming soon and they are flocking to long-term bonds. (Bond yields fall when demand is high.)
Historically, an inverted yield is a good indicator of recessions, which explains why the fear in the bond market spilled over into the stock market.
However, there is a difference between the past and now. In recent decades when inverted yields correctly predicted recessions, the inversion happened when short-term rates rose while the long-term rate mostly held steady.
That’s evidence the Federal Reserve played a role in pushing the economy into recession by raising the benchmark short-term interest rate to fight inflation. (The Fed controls short-term interest rates and has more influence over short-term yields while market demand determines long-term yields.)
Today, the inversion is caused by a steep fall in the long-term Treasury yield that caused the inversion. Fear that the trade dispute between U.S. and China could get out of hand and drag down the entire global economy drove investors to seek out Treasurys as a haven.
Fortunately, the Fed now sits in a position where it can cut the federal funds rate to help push the short-term yield lower and that would make an inverted yield unlikely to last. One thing’s for sure, the Fed will not be raising short-term interest rates anytime soon.
This doesn’t guarantee that a recession will be avoided, but it means that the Fed has the tools to help support the economy. If the federal funds rate were still at zero, we would be in a lot more trouble.
Alternatives to Long-Term Treasurys
For conservative investors who just want to preserve capital, it makes sense to snatch up some long-term Treasurys in case the stock market goes awry.
Other investors, though, may want to consider other alternatives.
If you invest in long-term Treasurys and the economic outlook worsens, the Treasurys will likely increase in value. However, if the economic outlook brightens and investors’ risk appetite returns, bond prices will likely fall.
If you want to sell your long-term bonds to get back into stocks, you may end up losing money on the bond trade. If you hold on to them, your money will be locked up in a low-return instrument for many years.
Given the inverted yield, you can now purchase a shorter-term fixed-income instrument (debt) for a higher yield. For example, the one-month Treasury bill offers a higher yield than the 10-year Treasury note. Some short-term CDs also offer higher yields. CDs are FDIC-insured up to $250,000 per person per bank so there’s virtually no risk of loss. Today, even some money market funds offer higher yields, but these funds are not FDIC-insured and their rates aren’t locked in.
Of course, there isn’t one strategy that will work for everyone, so it’s best to consider your own situation before making moves. Today’s inverted yield, however, offers a rare opportunity. Investing in shorter-term debt reduces your stock exposure for the time being while retaining flexibility. When the short-term notes mature, you can reassess the situation and decide what to do then.
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