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Forward Returns Following A U.S. 10-2 Year Yield Inversion

ByCity Index
AuthorMatt Simpson
Published 08/29/2019, 02:41 AM
Updated 12/14/2017, 05:25 AM

A look at how markets have performed following a U.S. 10-year:2-year yield curve inversion.

Unless you’ve been living under a rock, you may have heard a thing or two about the yield curve inverting in the news recently. In fact, you probably heard the several months lead-up to its potential too. Well, the yield curve has indeed inverted and sparked a fresh round of calls for a recession some time over the next 20 or so months (although estimates do vary in the timing).

As my colleague Joe Perry pointed out, regardless of whether a session materialises, equites have tended to bounce after such a signal. So, we’ll start with backing this up with a chart and see how other markets reacted following an inverted 10-2 year yield curve.

S&P 500 Index/d

  • Basically, an inverted yield curve has been positive for stocks overall

  • Median prices (ie typically) trend higher between 0-3 months after the yield curve inverted

  • Interestingly, on average the S&P 500 was trading lower from 1-2 weeks out, but overall trends higher as it moves towards +3 months

  • With exception to the next day, average returns were positive over 50% of time
    • Light Crude OC/d

  • Somewhat surprisingly, WTI appears to show an even clearer trend than the S&P 500

  • Average returns are positive (and over 50% of the time) around the first week, and become increasingly more bullish from 1 to 3 months after the inversion

  • It’s good to see average and median prices moving in lockstep, as it suggests the average returns are not powered by a few outliers
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    Gold LBMA

  • Another surprise, this time from gold, where a trend is hard to decipher

  • My expectations of a bullish trend have not been met

  • With median prices negative one month after, with the average positive, there’s clearly some outliers here to push the average up

  • Overall, gold’s pattern it too difficult to decipher to read much into it, surrounding inversions over this time horizon
    • TR/CC CRB ER

  • Taking a broader look at commodities (using the CRB Core Commodity Index) shows that, overall, commodities come under pressure

  • That said, the trend is clearer on bearish average forward returns (outliers weigh it down) whilst median (ie typical) prices meander between bullish and bearish

  • Whilst we could argue broad commodity prices are bearish on average, the trend is not as compelling as seen on S&P 500 or WTI
    • HG Copper SEP 9/d

  • Copper prices tend to come under pressure for the month following the yield curve inversion

  • Median prices remain bearish for up to 3-month, yet peak around 6 weeks after the signal

  • Average returns are notable bullish 3 month out, although likely fueled by outliers as median remains bearish

  • On average, forward returns are bearish over 50% of the time from T+3 onwards
    • ISH MSCI EM MK/d

  • It appears that emerging markets (EEM ETF) love a good yield curve inversion.

  • What’s compelling about this chart is how average and forward returns are clearly trending higher (and increasingly so towards +3 months) whilst also over 50% of the time (excluding the day of the signal
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  • However… it should also be noted that the technicals for the EEM ETF do not currently align with this bullish view, so we’d urge to wait for a basing pattern to be confirmed before assuming a low might be in place

  • And this data set is only form 2005 (so a smaller sample size means its statistical significance may be less reliable)

    • Original Post

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