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We are now Very Close to a Yield Curve Inversion. We talked about this about A Year Ago.

In May last year, I wrote extensively about how the yield curve inversion can be used as a reliable indicator of a stock market decline. It was correct 7 out of 8 times since the data was available in 1960s. You can check out the posts I wrote in May 2018 at:

  1. Is Negative Treasury Yield Curve a Good Leading Indicator for a Stock Market Crash? You'll want to know...
  2. More Observations on the Treasury Yield Curve. Fasten Your Seatbelt.

Yesterday the Federal Reserve decided to hold interest rates steady and indicated that there will be no more rate hikes for the rest of the year. The benchmark funds rate would be kept in a range of 2.25 percent to 2.5 percent. The Fed's recent dovish stance and the global economic slowdown has pressured bond yields as investors moved their money to less risky assets.

I have been using the 10-Yr to 1-Yr Treasury yield curve for my analysis. Some say I should use the 10-Yr to 2-Yr which is more widely observed. To me, 1 year or 2 years doesn't make much of a difference. I prefer the former because there are more data freely available. As of this writing, the difference between 10-Yr to 1-Yr has fallen to 0.07 (It was 0.70 ten months ago). the difference between 10-Yr to 2-Yr current stood at 0.12.

And yes if you are observant enough, currently the 1-Yr rate is higher rate than 2-Yr. Here is how the current yield curve across the different maturities look like.

From the chart above, you can see that all the shorter term rates (1-mth, 2-mth, 3-mth, 6-mth and 1-yr) are already higher than some of the longer term rates (2-yr, 3-yr, 5-yr and 7-yr) and the shorter term rates are considerably higher than they were at the start of 2018. In my previous post, I was expecting the inversion to happen around the 4-5% region. From the looks of it, it would be tough to even reach 3%. The lower the rates, the lesser fire power the Fed has to deal with the impending headwind.

What is going to happen next? 
It is almost certain that the 10-Yr to 1-Yr (and 2-Yr) will invert soon. And with so many people looking at it, it could turn out to be even sooner when self fulling prophesy kicks in. 7 out of 8 times when it happens, a stock market sell-off will follow. It could be another 1.5 years like what happened in the 2008 Great Recession or it could have already started like in 1973. Remember we had a knee jerking roller coaster style correction last year? Those declines may have jolly well be the start of the next sell-off.

What will DIYQuant do?
As mentioned in previous post, the yield curve inversion is a great leading indicator to have but the lead time is not granular enough for DIYQuant. A range of lead time between 0 and 1.5 years is too wide. If you have sold off when the yield curve inverted in 2007, you would have missed a 1.5 years of the following bull run. DIYQuant trading model depends on a proprietary indicator called Market Wide Trend Analysis (MATA) that so far had been able to accurately indicate the market reversal in February 2018, October 2018 and the bullish reversal in late December 2018. Check out below posts on how MATA accurately predicted the market reversals. Still, I would not ignore an inverted yield curve.

  1. How my system predicted the recent downturn? By looking at the data objectively
  2. Once Again DIYQuant System Predicted the Market Reversal
  3. This Stock Market Decline has been Foretold Months Ago. It's all in the Data

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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