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More Observations on the Treasury Yield Curve. Fasten Your Seatbelt.

This post is an extension of my previous post on "Is Negative Treasury Yield Curve a Good Leading Indicator for a Stock Market Crash? You'll want to know..." In my previous post, I talked about how the yield curve can be used as a reliable predictor of stock market crashes and presented my analysis of its reliability based on historical data dating back to 1960s. It is an observation that I strongly believe should not be taken lightly. In this post, I am going to make more observations on the yield curve and where I think we are heading now. Honestly, I don't feel excited about writing this post, given where I think we are heading towards (I hope I am wrong though).

Similarly, I will be using the 10-yr to 1-yr Treasury yield curve for the analysis. The convention is to use 10-yr to 2-yr yield curve but I think it does not make a lot of difference here. Here is the same 10-yr to 1-yr yield curve chart since the 1960s including the prices of both the 10-yr and 1-yr treasury yield (in reds). 

What did you observe?

I did not perform any number crunching here, just merely eye-balling at the chart as a trend follower. This is what I observed.

Observation 1
The yield curve inverts when the shorter term 1-yr yield 'catches up' with the longest term 10-yr yield to form a local maxima (purple arrow). This makes sense since shorter term yields are lower and tend to be more volatile. An interesting observation is it always happens when both yields are rising. That's why I use the term 'catches UP'. 

Observation 2
Since the 1980s, every subsequent yield curve inversion and market crash is accompanied by the yields making lower highs. In fact, the yield has been in a general downtrend since the 1980s (yellow arrow). I believe that for the next market downturn, the yield will be at an even lower highs. After a market downturn or recession, the Federal Reserves and Central Banks would lower interest rates to reduce borrowing cost and spur the economy with other cheap monetary policies which in turns would depress the rates further. From the chart, we can see that there is not much further downwards we can go. Unless we get into negative rates territory, where one has to pay in order to save. Then the question is what would be the impact? Denmark and Japan had done it. So far, it doesn't feel that bad. But what if it happens to US? How low can we go and what value is the tipping point? This would be an uncharted territory. All in all, I think things can get pretty ugly. 

So where are we now and what's next?

When I wrote the previous post on yield curve inversion, the 10-yr to 1-yr Treasury yield curve was at 0.7. As of this writing. it has dropped to 0.66. Both yields are currently rising and the shorter 1-yr yield is catching up with the 10-yr yield. My guess based on the trend is that the curve would invert around the 4-5% region, or lower. When would it happen? I don't know. After the yield curve inverts, there will likely be a market downturn. How bad can it get? Well, it appears to get worse everytime. Now that there is not much room to play around with the rates, let's hope the Feds and central bankers can pull another rabbit out of the hat. 

Would this time be different?

Maybe yes, maybe no. But based on the trends, I wouldn't bank on it that this time would be different.  It is better to have a proper risk management plan in place when the time comes. Just as when the sky is dark, I would bring an umbrella with me when I go out. It may not rain in the end. But when it does, I have my umbrella.

This article is based on my own analysis and my own opinion of the outcome. This does not constitute an investment advice and readers should perform own due diligence when making investment decisions.

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