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Income Investors: Keep Your Eyes on the (at the Moment Not) Inverted Yield Curve

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Income Investors: Keep Your Eyes on the (at the Moment Not) Inverted Yield Curve

Income Investors: Keep Your Eyes on the (at the Moment Not) Inverted Yield Curve

The yield curve is no longer inverted, but that doesn't necessarily mean income investors wary of economic growth and risk assets should pile into treasuries.

On Oct.

11 the yield on the 10-year exceeded that of the 3-month bills for the first time in several months.

A prolonged inversion of the two yields often indicates that a recession is coming sooner rather than later, as investors seek to protect their capital over the long term, while expecting economic growth and inflation to be muted.

Bond yields fall when their prices rise.

The slightly positive spread in yields now comes as investors have grown incrementally more optimistic.

A few blips of positive trade news, namely President Donald Trump and China commenting that they're interested in a partial trade agreement, have come out recently.

Meanwhile, of the 15% of S&P 500 companies that have reported third-quarter earnings, 84% have beaten earnings-per-share expectations, according to FactSet data.

Investors have moved out of the safer 10-year treasury and into stocks.

The S&P 500 is up 3.8% since Oct.

11.

But one strategist reminds investors that they shouldn't become too optimistic on the yield curve and that global financial conditions indicate that U.S. yields are bound to stay muted.

"The yield curve is no longer inverted but continues to reflect the pressures of an increasingly yield-thirsty world," Jason Pride, chief investment officer of private wealth at Glenmede, wrote in a Monday note.

"All things considered, although the yield curve is no longer inverted, it still remains relatively flat." It may not come as a surprise that the yield curve remains meaningfully flat compared with history, but for context, Pride flagged what a normal environment would look like.

In the past 20 years on average, the 10-year treasury bond has yielded roughly 4%, while the 3-month bill has yielded just above 1%, representing a far healthier spread than the current one.

Here's the point: Looking forward, investors may not have much opportunity to jump in for higher yields.

Pride explained that globally right now, about $13 trillion debt has negative yields.

In Germany, historically one of the world's strongest economies, the 10 year bund is yielding -0.35%.

Japan's 10-year treasury yields 0.13%.

This has caused waves of capital to periodically flow into U.S. government bonds, as those generate the highest yields in the world.

That pushes U.S. prices up and yields down.

Pride says this dynamic is likely to keep rates at historically low levels.

This may cause momentary price appreciation, but the long-term investor looking for solid yield will be hard-pressed to find as much.

One factor that could move the U.S. yield curve further toward normalization is Federal Reserve interest rate cuts.

This would pressure short-term treasurys and theoretically stimulate the economy.

Some would say the Fed can't act as a stimulant much longer.

But if the Fed succeeds in spurring growth, money would flow away from longer-dated bonds.

The yield curve would steepen.

Still, many on Wall Street recommend dividend stocks for the defensive investor, many of which yield 3% or 4%.

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