If you feel like you keep seeing headlines pop up with the words: “inverted yield curve” and “recession watch,” you’re not alone. And although you may understand the general gist of what’s driving these headlines (a reflection of treasury bonds, interest rates and time to maturity), what does it all mean? Let’s break it down and explain what it could mean bigger picture, for you.
First, it’s important to have a grasp on what the yield curve is before we evaluate what an inverted slope means. Taking it back to good old economic class, remember, a yield is the return on an investment or security, so a yield curve will plot the interest rates of bonds having equal credit quality, but different maturity dates. Meaning, it provides an outlook of future interest rate changes, economic activity and potential returns. The most frequently reported yield curve compares the three-month, two-year, five-year, 10-year and 30-year U.S. Treasury debt (or treasuries). This is a useful tool in finance as it is used to benchmark and guide other debts, including mortgage rates and lending fees that could impact you.
When the yield curve is normal (or upward-sloped) it shows the yields on longer-term bonds are higher than shorter-term bonds, as typically expected due to the increased risk premiums for longer-term investments. This trend indicates the economy is growing and consumers are investing accordingly.
However, when the yield curve is inverted (or downward-sloped) it means the opposite -- longer-term bonds have lower yields than shorter-term bonds. When this is the case, consumers tend to take a “wait-and-see” approach and not invest, considering the future of the investment appears volatile. This trend has often been associated as a predictor of a recession. Historically, inverted yield curves have preceded many U.S. recessions, including late 2005, 2006 and 2007 preceding the 2008 financial crisis and equity market collapsing.
Although this yield curve is specific to treasury bonds, it is still a driving force behind interest rates on other loans with similar lengths. To remain competitive, interest rates on consumer or business loans will increase as treasury rates increase. Since lenders have to pay higher short-term deposit rates while earning a lower interest rate, credit standards will also go up and less borrowing may occur.
Although nobody has a crystal ball to predict whether a recession is on the horizon or not, there are some steps you can do to prepare yourself, and your loved ones, in case we do see a downturn:
- Revisit Your Emergency Fund: first things first, prioritize building up your emergency fund. A good rule of thumb is to have three to six months of living expenses covered in a savings account (depending on your lifestyle and situation). Having this emergency fund will help support your peace of mind in the case you need to dip into it.
- Review Your Expenses: instead of waiting until you need to cut costs, be proactive and review your budget and list of expenses to determine if anything can be cut or reduced now. Whether that includes your phone bill, cable, monthly subscriptions, etc., take a budget-conscious lens to optimize your spending.
- Review Your Insurance: it never hurts to hit pause and take a look at your disability insurance, life insurance and any other benefit elections you have. If you breezed over this when you got hired or during open enrollment periods, now is a good time to revisit what you have and what that means for you and your family. You should also ensure all dependents are up-to-date.
- Reflect on Your Job: take some time to reflect on your current job. Are you up for a promotion? Are you happy with your current responsibilities? Is there an opportunity for overtime or to pick up some extra shifts? Don’t overlook any opportunities you have with your current employer.
- Consider a Side Hustle: if you need to help build up a financial cushion and your current income stream isn’t covering it, consider a side hustle. Especially with the upcoming holiday season, it’s a great time of the year to pick up something part time to make some extra cash.
- Stay the Course: no matter what the future holds, it’s important to keep your financial goals top of mind. Continue paying down debt and keep investing to support your overall financial health and your future. Keeping an eye on your credit score and future investments will only pay off in the long run.
- Think Positive: remember there are some positives that you can take advantage of during a recession if you’re in a position to do so. For example, the cost of a mortgage may be more affordable or you may consider refinancing to take advantage of the lower rates.
- Be Resourceful: as always, there are professionals here to support you so you don’t need to go at it alone. Consider talking to a financial advisor now to ensure you’re set up for success for different economic conditions. Discuss your concerns and thoughts to help you feel confident in your decisions.
Financial health means weathering the storm – through both good times and bad. Although nobody can guarantee a recession is coming, the inverted yield curve is an indicator you should at least be prepared in case it does. In fact, we should always be prepared but sometimes an extra nudge is needed to put it into action.
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https://www.investopedia.com/terms/y/yieldcurve.asp
https://www.investopedia.com/terms/i/invertedyieldcurve.asp
https://www.forbes.com/sites/camilomaldonado/2019/10/04/7-things-prepare-for-recession/#76f448f7518b