Different corners of the bond market are giving very mixed signals right now. While credit markets are signaling “all clear”, Treasuries are screaming recession warnings.
Credit spreads are the premium paid on borrowing costs for riskier companies. Generally, spreads widen when there are recession worries and contract during rosier times. Right now, BBB rated corporate bonds trade at a 1.88 spread, which is higher than average, but certainly not crisis levels and well off the highs from earlier this year (see Chart 1 below).
The Treasury yield curve is telling a different story altogether. In normal times bond yields are higher for longer maturity dates to compensate investors for locking in money, much like a 30-year mortgage has a higher rate than a 15-year mortgage for home buyers. Yield curve inversion is when longer dated bonds yield less than short term bonds. It occurs when markets believe that the Fed will have to cut rates in the not-too-distant future, and it is considered a fairly accurate warning sign for recession. Presently the yield curve is at its deepest inversion since the early 1980’s (see Chart 2 below).
We think it is unlikely that the Fed will be in a position to cut rates to a stimulative setting in the absence of a recession for fear of stoking inflation again and undoing all the work done in 2022 to contain it, as detailed in “Soft Landing and Low Rates are not Compatible”. As such, we feel it is likely that the markets will have to adjust with either credit spreads rising (which could be accompanied by some stock market weakness) or longer dated yield expectations adjusting higher.
Important Disclosure Information:
Sources include eSignal.com, Bureau of Economic Analysis, Bureau of Labor Statistics and FactSet. Not a substitute for tax or legal advice.
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Grimes & Company, Inc. [“Grimes”]), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Grimes. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Grimes is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Grimes’s current written disclosure Brochure discussing our advisory services and fees is available for review upon request or at www.grimesco.com. Please Note: Grimes does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Grimes’s web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Please Remember: If you are a Grimes client, please contact Grimes, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. Please Also Remember to advise us if you have not been receiving account statements (at least quarterly) from the account custodian. Historical performance results for investment indices, benchmarks, and/or categories have been provided for general informational/comparison purposes only, and generally do not reflect the deduction of transaction and/or custodial charges, the deduction of an investment management fee, nor the impact of taxes, the incurrence of which would have the effect of decreasing historical performance results. It should not be assumed that your Grimes account holdings correspond directly to any comparative indices or categories. Please Also Note: (1) performance results do not reflect the impact of taxes; (2) comparative benchmarks/indices may be more or less volatile than your Grimes accounts; and, (3) a description of each comparative benchmark/index is available upon request.