Inverted yield curve: what it means (and it’s not what you think) | Pendal Group
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Inverted yield curve: what it means (and it’s not what you think)

The current yield curve inversion — where short-dated bonds yield more than long-dated bonds — may not mean a recession is imminent, argues Pendal’s OLIVER GE

THE prospect of stagflation has been the talk of markets in recent weeks as rising short-term interest rates push the bond yield curve into inversion, flagging a sign of impending recession.

An inverted yield curve — where shorter-dated bonds yield more than longer-dated bonds — is an important indicator for investors.

Longer-dated bonds usually pay higher interest rates to compensate for their increased risk over time. But right now short-term interest rates are moving closer to — and even higher than — long term rates.

That’s important because it’s traditionally a harbinger of recession.

But with a strong global economy, low unemployment and benign equity market conditions, analysts have been looking for an alternative explanation for the inversion other than a surprise descent into stagflation and recession.

Oliver Ge, a portfolio manager with Pendal’s Income and Fixed Interest team, says the yield curve inversion may also be explained by expectations that current inflationary pressures are only short term.

“There are two ways this can be interpreted,” says Ge.

“In one sense you can see it as a sign of recession. But I don’t think that’s the case”.

“Instead, what we’re seeing in the market is that short-dated bond yields are higher because they carry a premium to their longer-dated counterparts to compensate investors for bearing higher near-term inflation risk. That’s what’s driving the inversion”

Stagflation is a worry for markets because it means a toxic combination of rising prices and lower economic growth.

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Pendal’s Income and Fixed Interest funds

But Ge says the conditions for stagflation are not present in the global economy.

“There’s 1.8 jobs available for every person who wants a job in the US,” he says.

“That’s more jobs per person than there has ever been.

“In Australia, the workforce is in a stronger position than it was pre-pandemic. We’ve recovered all the job losses we had in the pandemic and created more and there are still labour shortages.

“Some say it’s about borders and immigration — but this is a global phenomenon. The overriding theme across the world is employment is fantastic. There are jobs for everyone.”

Ge says in such a strong economic environment, it’s difficult to believe that a few interest rate hikes will stop businesses hiring.

Returning to recession so soon after the global pandemic downturn would also be surprising from an historical view, he says.

“Looking back, you see a recession every eight to 10 years or so. The yield curve is telling us there is a recession around the corner but that’s almost never the case historically.

“Maybe you get a bit of a slowdown, but you don’t get the end of days that some people are calling for.”


About Oliver Ge and Pendal’s Income and Fixed Interest boutique

Oliver Ge is an Assistant Portfolio Manager with Pendal’s Income and Fixed Interest (IFI) team.

Oliver works on developing and running key quantitative investment models, and acting as trading support for the Income & Fixed Interest team. Oliver received his Bachelor of Commerce (Finance) from the University of Sydney and is also a CFA Charterholder.

Pendal’s IFI boutique is one of the most experienced and well-regarded fixed income teams in Australia. In 2020 the team won the Australian Fixed Interest category in the Zenith awards.

The invests across income, composite, pure alpha, global and Australian government strategies.

Find out more about Pendal’s fixed interest strategies here


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