The Yield Curve Has Been Inverted For 14 Months. Is this Proof of the “Soft Landing”?

Since July of last year, 10-year/2-year spread has gone inverted. The 10-year/3-month curve has been inverted for the same amount of time, at one point even hitting a 2% differential.

How has this affected our clients’ portfolios?
First off, it is a no brainer to purchase short term Treasury Notes rather than the typical long-term bonds. When your money is tied up, you should receive a premium. Since that does not exist in the current market, liquidity is clearly king.

Is the Soft Landing becoming a reality?
We have heard a lot about the “Soft Landing” by Jerome Powell over the past year. The idea is that we slow inflation by bringing up the federal funds rate WITHOUT increasing unemployment and therefore without a recession. This proves to be incredibly difficult because the rise in interest rates leads to difficulty borrowing. Difficulty borrowing means less spending, which leads to a decrease in company profits. This can, of course, lead to increased unemployment due to a lack of demand.

There are multiple challenges with the soft-landing theory, though. First off, The Soft Landing has been achieved just once, [wsj.com] in 1995 and early 1996. This was successful enough that the next recession took place years later, sparked by the Dot Com Crash from 2000 to 2002.

It’s Not When We Invert, but When We Revert
Ultimately, the inversion of the yield curve is a great tell of troubles to come. It has accurately predicted each of the past 6 recessions. However, a recession has not occurred until AFTER the curve reverts [get.ycharts.com]. Why is this the case? When economies drop, The Fed tends to drop rates. It is a reactive move that pulls the 2-year (or 3-month) yield lower than the 10-year.

What Can We Do About This?
Ultimately, we run into the never ending challenge of timing the market here. Personally, I believe that we will see rates drop after unemployment and other recession factors tick up at the start of 2024. When that happens, I expect long term bond funds like TLT and IEF to rocket higher.

Currently, I hold long calls on TLT and many shares of SHY and IEF (short and long term bond funds, respectively) along with various puts on the market, all set to expire mid 2024.

Everything I see suggests this is a great time to get conservative at the very least. But in order to profit, we grease the wheels with some shorts.

Have a great week!

Ryan

Financial Disclaimer:
This newsletter provides educational content only, not financial advice. Conduct your research and consult with a qualified professional before making any decisions. We are not liable for any losses incurred based on the information provided. Invest with caution and consider your risk tolerance.