This past week has been a roller coaster for stocks. Last Wednesday stocks rallied strongly in response to comments from the Federal Reserve Chairman, Jerome Powell. Mr. Powell implied the Fed may be close to slowing the pace of increases in the Federal Funds rate, or perhaps even ending them altogether. This is an important milestone as concerns have been growing that the Fed could squelch what is already slowing global economic growth.
Fueling the rally further was the news on Monday that Washington and Beijing had called a 90-day halt to new tariffs along with encouraging comments that progress was being made in trade negotiations. The stock rally was in full swing.
Or so we thought. Yesterday, the primary U.S. stock indexes were pummeled in the range of 3.1% to 4.4%, eradicating most of the gains of the previous week. So what changed? Of lesser significance was discouraging comments with respect to trade with China and Federal Reserve interest rate policy. Of far greater impact was the near-flattening of the 10-year versus 2-year Treasury yield curve. Recall that every recession over the past 40 years has been preceded by a flat or inverted yield curve, meaning long term interest rates were the same as or lower than short term rates. Yesterday the rate differential hit a paltry 0.13%. Importantly, the yield curve comparing the 10-year Treasury bond versus the 3-month Treasury bill remains more positive.
In light of the nearly flat yield curve, we revisited our research examining the impact of a flat yield curve on stock market performance. For this study we used the S&P 500. On the prior three occasions when this yield curve went flat, stocks did not top out for another 1 ½ to 2+ years. Going back to 1978, stocks initially dipped and then rallied for the next two years.
At this point in time I’m not overly concerned about the flattening of the yield curve.
Glenn S. Rank, CIMA®
Certified Investment Management Analyst®