After the yield curve inverted on Wednesday, August 14, financial headlines turned grim.   ”Longer-term rates below shorter term rates are a clear signal from bond investors that they think the United States economy is on the downswing, that its future looks worse than its present.”  But this widely-held view in the financial press may be relying more on the yield curve than they should.  In the past, when the yield curve inverted, it was because investors saw fundamental economic measures slowing down, but that’s not happening now.  

Newly released data shows retail sales surged 3.7% in the 12 months through July!  That followed a 3.8% spike in June and a 3.1% rise in May!  Since 70% of U.S. economic activity comes from consumers, the continued strength in retail sales dampened fears of a recession.  When consumers are spending like this, you can’t just have a recession!

The retail numbers are part of a growing body of evidence that the yield curve may be making a recession look much closer than it actually is. While the yield curve is an important economic forecasting tool, it may not be the best tool to forecast the future right now.    To drive on the road ahead, you don’t want to be driving your car from your rear view mirror!

Things really are different this time because the inversion of the yield is caused by an unprecedented condition: Negative yields in Europe and Japan, which are depressing yields on long-term U.S. bonds — causing the inversion!   What investors expect of the economy over the next 10-years is not really bleaker than what they expect over the next three months, but negative yields in Europe and Japan have attracted capital to U.S. bonds and depressed yields in the U.S.

From a prudent professional’s perspective, the inversion is a technical market problem of supply and demand and not a real economic problem.    It’s prudent to expect lower returns on fixed-income portfolio allocations in the years ahead, but that doesn’t mean the U.S. is headed for a recession.  Fear about the inversion of the yield curve heightened stock market volatility, but that does not mean the decade-long, expansion-fueled bull market is over.