Outlooks in the time of the inverted yield curve

For a few years now, there have been whispers of an impending recession. For all of that talk, though, it has always seemed to be coming but never quite happening. With the arrival of coronavirus onto the world stage, a recession (and potentially worse) is inevitable. Economists are closely looking at global indicators, and investors and non-investors alike are in an economically fearful state of mind.

One factor used to gain a better picture of both the global and domestic economies is bond market performance. And now is a good time to review what the experts have been seeing.

Bond market vs. stock market

While stock market performance gets all of the headlines, it’s the bond market—quietly performing in the background—that economists also study to gauge the economy. Although bonds and stocks tend to compete with one another for investment dollars, bonds traditionally do not have the levels of volatility and speculation associated with stocks.

As a result, bonds—a tool for the government or corporations to sell off debt—are often considered a better gauge of understanding the mindset of many investors. The bond market can sometimes provide a good picture of the economy 6 to 12 months from now.

Taking a closer look at yield curves before the crisis grew

One of the first indicators experts consider is the yield curve in the bond market. Generally speaking, the curve is based on the yields of various bonds with various term structures and maturity terms. The most commonly watched yield curve is between the two-year and 10-year bonds. Traditionally, short-term bonds have lower yields than long-term bonds because investors require more compensation for having their money tied up for a long period.

Yield rates are determined by the Federal Reserve, investor demand, and the banking industry. A change in rates changes the curve. Essentially, there are four types of curves:

  • Normal: This model has low yields for short-term bonds that increase and ultimately level off for bonds with a longer maturity. A normal curve is indicative of a stable economy.

  • Steep: Although similar to a normal curve, the steep model has higher yield rates along the curve with longer-term bond yields soaring upward. This indicates a growing economy.

  • Flat: As the name says, this curve is barely a curve at all. It’s basically a flat line and indicates uncertain economic times.

  • Inverted: The inverted model is the complete opposite of the normal yield curve. Here, short-term bonds have higher yields than long-term bonds, resulting in a downward-sloping curve. This is usually a warning that investors do not want their money tied up for extended periods for fear of an impending recession.

CRE in the time of an inverted curve cycle

While most economists agree that inverted curves are rare, the world economy had been drifting in and out of an inverted cycle for months before the current crisis, especially in European and Asian markets. The pre-coronavirus strength of the US economy in other sectors—such as consumer confidence, job growth, low interest rates, and yields slightly above those in other countries—seemed to be compensating for the inverted curve and holding off a recession.

This outlook started to change in February of this year when coronavirus fears swept around the globe. By March, in an effort to provide support for the economy, the Federal Reserve, in a coordinated effort with the Bank of England and the Bank of Japan, slashed its key interest rate to just above zero. Stocks tumbled, and the yield curve for 10-year bonds fell below that of two-year bonds. Simply stated, the steeper the inverted yield curve, the louder the recession alarm.

CRE and the implications of coronavirus

In a “normal” situation, some experts believe an inverted curve cycle can be good for CRE. To protect the yields gained in short-term bonds, investors turn toward the strength of commercial real estate. Similarly, investors looking for the higher yields once promised in long-term bonds also look to CRE, specifically in the industrial and multi-family sectors.

These days, as you are well aware, are far from ordinary. While lower interest rates are designed to encourage borrowing, this recent cut happened at a time when businesses have been forced to shut their doors, and workers are quarantined to their homes. Additionally, this is entirely new territory, and there is really no way to predict how long the impact of coronavirus will last—nor how deeply it will cut.

Supply lines, like those needed for remodels and new construction, may be disrupted. At the same time, some economists believe the Fed acted too swiftly, limiting a key policy tool usually reserved for counterbalancing an actual recession.

Even the best predictions are fluid

Experts are presently looking at three recovery scenarios: V-shaped, U-shaped, and W-shaped. In the first case (V), there is a rapid return to normalcy, with eased travel restrictions, the discovery of a vaccine, and growing confidence to re-open schools and businesses. On the other hand, a U-shaped recovery is slower, with coronavirus holding the steering wheel for the global economy. And W-shaped is a worse scenario, with a recovery hit hard again by further outbreaks and negative economic impacts.

As virus data is collected and analyzed—and indicators show the economy potentially moving into one of these scenarios—banks will respond accordingly.

The only accurate predictions that can be made, right now, is that the emphasis will remain on the essential health and welfare of billions of people—and that COVID-19 will continue to take a drastic toll on the global economy.

As always, Morris Southeast Group is committed to meeting your CRE needs. More importantly, we want all of you to stay healthy, heed medical advice, and take necessary precautions for you, your families, and your businesses.

To learn more about what Morris Southeast Group can do for you, call us at 954.474.1776. You can also reach Ken Morris directly at 954.240.4400 or via email at kenmorris@morrissegroup.com.


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