Hi, I'm Jimmy in this video.
We're going to walk through the inverted yield curve.
Now, this is important because the yield curve recently inverted once again and this often
indicates that a recession could hit the US in the not too distant future.
Now, just so we're all on the same page.
Let's quickly look at what an inverted yield curve is and then we can see if we can prove
that works.
Then we'll look at the yield curve in 2020 and see how this could be a problem for the
United States economy.
So this is an example of what a normal yield curve looks like.
And basically, here's what we're looking at.
So let's imagine that this is today's yield curve.
Well, if we invest in the in a U.S. Treasury, if we invest in a U.S. Treasury that matures
in three months.
Well, that would pay us maybe a 3 percent annual rate.
But if we were to invest that same money for two years, we could get 5 percent or 30 years
we could get 7 percent.
So this is a normal yield curve.
This makes a lot of sense if we think about it.
If we're going to lock up our money for a longer period of time, what we would expect
to be compensated for doing that.
So what is an inverted yield curve?
Well, here's an actual example of an inverted yield curve.
This is what the U.S. Treasury yield curve looked like before the tech bubble burst back
in 2000.
And as we could see, short term rates were above long term rates, which is the exact
definition of an inverted yield curve.
Now, if you're curious to see this whole chart as far as it applies to the S&P 500, well,
this is what the S&P 500 looked like back then.
And this box is when the U.S. economy went into a recession, because we can't forget
that the yield curve is not actually predicting a stock market crash.
It's predicting a recession.
Now, many times a stock market crash and a recession will happen simultaneously.
But either way, the goal of this is to predict the recession.
So this is where the yield curve inverted.
And that was like nine or 10 months after that is when the US hit the recession.
Now, at that time, when the yield curve inverted, well, it stayed inverted for more than 10
days.
And I've heard that 10 days is typically the number that we're looking for, although there's
no exact definition of how long it needs to stay inverted.
If it was let's say it was just nine days, I'm not sure I'd feel much better about it.
But either way, this one was inverted for more than 10 days, which is always what I've
heard.
What you're looking for then skipping ahead to the Great Recession.
This is what the yield curve looked like in August of 2006.
And once again, short term rates were higher than long term rates, once again giving us
an inverted yield curve.
That's what they mean by inverted when short term is higher than long term.
And we may also notice that this inverted yield curve looks a bit different than the
inverted yield curve from before the tech bubble.
And that's OK.
They don't have to look the same.
The point is that short term rates are higher than long term rates.
OK.
So now jump into the Great Recession S&P 500 chart.
This is where the US economy actually entered a recession.
And then this is where the inverted yield curve happened.
This was about 15 months before the US economy hit the recession.
So now we're starting to get an idea of how far after the inversion of the yield curve
have recessions, recessions actually happen.
OK.
And this brings us to today.
Now, I think it's important to point out that the yield curve first inverted back in March
of 2019 for a few days.
It wasn't for the full 10 days, but it was still inverted for at least a few days.
Then it inverted again in June of 2019.
And this time it was more than 10 days.
So that in theory, is the stronger of the two signs.
But either way, it inverted twice in 2019.
So now it's been about eleven months since the first inverted yield curve in about eight
months since the second inverted yield curve to today.
So clearly we're getting to the point, at least based on the past two recessions, that
this could soon begin to be a problem for the U.S. economy.
And then we switch over to the yield curve as of the start of January.
I'm just going to run through the days.
You'll see it there.
And we could see that in early January.
The yield curve had was a normal yield curve.
And then when we got towards the end of January, where we can see that, things started to look
a little bit different.
In fact, on the last day of January, the three month yield was higher than both the two year,
five year and 10 year yields, which is clearly a bad thing.
This is an inverted yield curve.
And then if we were to fast forward a few days.
Well, as we could see that as of yesterday, the three month stayed ahead of both the two
year and the five year yields, which is typically not a good thing for the economy.
So switching back to the S&P 500 chart, where we can see that once again, now we have another
inverted yield curve.
But here's why this most recent inverted yield curve is so important.
So just because A, there is a yield curve inversion, well, that doesn't guarantee that
a recession is coming.
Sure.
All recessions have been.
Seeded by an inverted yield curve, but not all inverted yield curves have led to recessions
and clearly the government, the Federal Reserve.
Well, they don't want a recession to come.
So after the first two inversions of from during last year, while the Federal Reserve
stepped in and started lowering interest rates a few times and just to illustrate that, I've
overlaid this chart with the brief timings of where the Federal Reserve lowered interest
rates and obviously this red line, which represents the Fed funds rate, well, clearly it's on
a different scale than the S&P 500.
I'm just overlaying it to point out the timing.
So clearly the few rate cuts that they've had by the Federal Reserve, those three rate
cuts, they were 25 basis points each, which totaled 75 basis points, which is the same
as three quarters of one percent.
And I'm sure that helped the stock market move higher towards the end of the year.
But it also helped normalize the yield curve, because when the Federal Reserve cuts interest
rates, they're really cutting short term rates, not long term rates.
So going back to the yield curve chart just for a second.
Well, what if the Fed lowered interest rates right now by 25 basis points?
Well, in theory, it would drop down the short term rate by 25 basis points.
And suddenly we have a fairly new looking yield curve at that point.
Now, it doesn't work exactly like this because technically the Fed doesn't control the three
month rate.
They control the Fed funds rate, which is technically an overnight rate.
So one day, twelve hours overnight, while it's a super short term rate, either way,
that's going to have more of an impact on the three month rate than it is going to have
on, let's say, the 30 year rate.
So the concept applies, even though it's likely that the full 25 basis points wouldn't show
up in the three month yield of the yet in the three month yield.
So wouldn't really drop by the full 25 basis points.
I'm just illustrating and that probably explains why they did three rate cuts for a total of
75 basis points to help spur the economy forward and straighten out this yield curve.
So the fact that we're now showing an inversion of the yield curve once again after three
rate cuts.
Well, this could be a bad thing for the economy going going forward.
Now, I do think it's important to point out that the yield curve isn't the only indicator
we should be watching.
I recently did a video called Can We Predict a Stock Market Crash?
And in that video, I used various economic indicators to see how they looked before the
Great Recession.
We went back in time to the Great Recession, said, all right.
How did all this stuff look back then and could be really used, that information.
Could we have would it have given us enough of a warning that the stock market was about
to crash?
So if you're curious, that could be a good next video for you to watch.
There's a link here.
There's a link in the description below.
And thank you so much for stick with me all the way into the video.
I really appreciate it.
Thanks.
And I'll see in the next video.