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The Yield Curve Is Moving Back To Normal. Does It Matter Anymore?

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For years, economy watchers have kept an eye on the yield curve. Inversion — when a shorter-term Treasury yield runs higher than a longer-term one, typically the two-year and the 10-year — has long been considered a predictor of recession.

The 10-year and two-year inverted on July 5, 2022, setting a new record. But so far, no recession. This is one correlation whose failure at prognostication would be welcome at the moment.

It’s been showing signs of reverting to normal. The two yields ended August 27, 2024, equal to 3.83%. On the 28th, the 10-year was one basis point above the 2-year, officially being a disinversion, however, on both the 29th and 30th, they were equal again. Then, September 3rd brought the two-year at 3.88%, four basis points above the 10-year’s 3.84%. After, the 10-year over 2-year, was 3.77% over 3.76% on the 4th; 3.73% under 3.75%; on the 5th; and 3.72% over 3.66% on the 6th.

In other words, the state of an inversion or not seems to be in an economic limbo. At this point, what does it all mean?

According to the Financial Times, there are two camps, both looking at the changes as investor expectations of coming interest rate cuts by the Federal Reserve. One says that the end of an inversion is a sign of a coming recession.

Deutsche Bank strategist Jim Reid told the FT that “we’re not out of the woods yet,” and that “the last four recessions only began once the curve was positive again.”

James Reilly, an economist at Capital Economics, told the paper that disinversion “has tended to precede recessions in the past . . . this move in yields is a symptom of investors’ worries rather than a new cause for alarm.”

No one knows with certainty the answer because all the factors are correlations that may not be causations. The Federal Reserve Bank of St. Louis’s FRED site has running data, starting June 1976, of the 10-year yield minus the 2-year yield. When the number is positive, the yield curve is normal. When it is negative, there is an inversion. Over that period, the timing between the start of an inversion and the following recession was roughly five months at the short end and 23 months at the long end. The current cycle already far exceeds the longest previous period.

Supposedly the Sahm Rule, which shows a correlation between changes in unemployment and the inception of a recession, says there may be a recession already. Claudia Sahm, the economist for whom the rule is named, has been cautious, having written in July that it “is likely overstating the labor market’s weakening due to unusual shifts in labor supply caused by the pandemic and immigration.”

Perhaps the best approach is to consider the potential impact of rate cuts. There are three meetings of the Federal Open Market Committee left in 2024. Markets have priced in a quarter point in September with a 40% chance of a 50-basis-point cut instead, the FT reports. And they expect just over 100 basis points of cuts by the end of the year. If good economic news continues, the Fed might make three 25-basis-point cuts and December’s meeting is in the middle of the month. There’s a limit to how large the total cut in rates could happen in the immediate future.

 

Source:  GlobeSt.

 

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Another Disaster Prediction Because Of Treasury Yield

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Trying to follow the economy at the moment is like watching a ping-pong game sped up for viewing whiplash. Last week the Federal Reserve held interest rates steady and indicated three possible cuts in 2024. CBRE had some optimistic capital market projections for next year.

And then? Jeffrey Gundlach — founder, CEO, and chief investment officer of Doubleline, and money management firm that is a big player in the bond market — said in a CNBC interview that when the yield level of the 10-year Treasury market goes below 4%, it sounds “almost like a fire alarm.”

“They believe, I think, that they’re done,” he said in the interview. “The Fed has been on hold for four of the last five meetings, so it’s a trend.” He added that his firm’s model suggests that headline CPI could be 2.4% by June. “If that’s the case, I think the Fed cuts rates.”

Gundlach also said he thought the 10-year yield would drop to the low 3s by sometime in 2024.

“I think we’re talking about a recession next year,” he said, also saying that there may be a breakdown of the correlation of strong bonds and strong equities.

That point is interesting and historically strange. Start with the old rule that a yield curve inversion — when the yields of short-term Treasury instruments are higher than long-term yields. The standard interpretation is that bond traders think that rates will be lower in the long term, which is usually associated with recessions.

While inversion has been a fairly reliable predictor of recessions in the past, it’s been far less certain recently. There was a period in 2019 when an inversion happened but the recession that would come was due to the pandemic and implosion of the supply chain. Not exactly what anyone might have expected.

And after? The curve inverted in early July 2022 and hasn’t returned to normal. But it was larger many times from 2022 on until now.

When the Fed announced the likelihood of cuts next year, stock prices shot up. But then yield prices started falling on 10-year Treasurys, which is odd, because typically, when equity prices go down, bond prices go up because investors move to what they feel is safer. As prices go up in bonds, yields come down.

What the market is showing is the exact opposite of what you might expect. Stock prices rose and bond prices rose, because yields dropped.

All this is to say that there seem to be some odd reactions across caverns that investors have come to trust.

 

Source:  GlobeSt.

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CRE Transactions Expected to Fall 5% Next Year Amid Rising Treasury Yields

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To understand where interest rates might go, watching the actions of the Federal Reserve is important, of course, but so is monitoring yields of Treasury instruments. Whether bonds, notes, or bills, depending on the term, they have great sway.

Treasurys are considered safe investments, and so are one of those practical baselines for calculating risk adjusted returns. As the yields rise, so do interest rates.

But as is true with anything, trying to track every movement can become confusing.

For example, CBRE noted on Thursday, November 3 that the “recent bond market sell off has lifted the 10-year Treasury yield to nearly 5% and further dampened investor sentiment for commercial real estate.”

 

“Rather than inflation, a mix of short- and medium-term economic and political pressures is driving up bond yields,” they continued. “These include a stronger-than-expected economy with robust consumer spending, increasing term premiums, the surging government deficit and reductions in the Fed’s balance sheet (quantitative tightening).”

Based on such data and their analysis, CBRE said that it lowered growth expectations for CRE investment rate volumes in 2024. The projection had been +15%; now they are -5%.

“Our econometric models indicate that the rise in the 10-year Treasury yield to 5% or more, if sustained, will raise cap rates and lower capital values for commercial real estate,” they wrote.

And if they were correct that the 10-year would continue a strong upward pace, maybe the impact of higher interest rates would have such an impact. They might even be correct.

But this is where following short-term data flows can drive people to potentially make mistakes.

On Wednesday November 1, the 10-year dropped from the previous day’s 4.88% yield to 4.77%. Then on Thursday, it hit to 4.67%, and Friday closed out at 4.57%. Similarly, the 2-year yield went from 5.07% on Tuesday to 4.83% on Friday.

Econometric models can be wrong. Then again, they could be correct, look further out, and maybe yields will rebound in the long run.

But then, CBRE wrote that other than office, the “relative health” of CRE property types “makes forward internal rates of return (IRRs) increasingly attractive.”

“If the economy manages a soft landing and long-term bond rates ease, investment activity may surprise on the upside,” they wrote.

This is why solid hedging strategies make a great deal of sense.

 

Source:  GlobeSt.

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