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The Inverse Yield Curve is Upon Us

By Brian Beaulieu on December 6, 2022

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Brian Beaulieu

Brian Beaulieu has served as CEO and Chief Economist of ITR Economics™ since 1987, where he researches the use of business cycle analysis and economic forecasting as tools for improving profitability.

ITR Economics is gearing up to change some forecasts for 2024 and 2025. The reason is the 3-month Treasury yield is running above the 10-year Treasury yield, and the situation has persisted for two consecutive months.  

Of our clients scheduled for a December 2022 report, 41.7% have historically demonstrated no ill effect from an inverse yield curve. One company seems to benefit from the occurrence of an inverse yield curve.

For 30.6% of our client data series, the occurrence of an inverse yield curve either has a demonstrable adverse effect or may have an adverse effect, but we can’t be certain because of insufficient historical company data. ITR Economics will be looking into the forecasts for these company series to determine whether they need to be altered based on the current inversion. It is worth noting that the time between inversion and company response varies from one company to the next and, to a lesser extent, from one inversion to the next.

We can’t be sure about the inverse yield curve impact upon 26.4% of the companies because of a limited data history. What we will do in these instances is examine the external variables associated with each company series to determine if the company’s markets are susceptible to an adverse reaction.

Management action: Know how your company responds to the existence of an inverse yield curve to effectively prepare for the next several years.

Fed Funds Rate Ascent

The Federal Reserve isn’t done raising the fed funds rate in its quest to tamp down inflation (even though much of the inflation is beyond its control). Examining our client company data for December revealed that 45.2% of our clients have demonstrated zero to low sensitivity when it comes to a rising trend in interest rates looking three years beyond the onset of the rising trend. These companies may be impacted in 2026 by the rate trends of 2022. The 43% cited in this instance is not the same list of companies as cited above because of the four-year threshold and because of data availability. Inverse yield curves are rarer than instances of the Federal Reserve simply pushing interest rates higher.

Management action: Know your company’s interest-rate sensitivity. If you don’t know, we can help you.

COVID-Echo Concerns

The inflation hitting the economy and the subsequent rising trend in interest rates are COVID-Echoes. We would not be contending with them (at least to the extent we are) if the pandemic had not occurred. There is another echo we are concerned about. The effect was a rapid and unsustainable rising trend in some measures of economic activity because of some combination of the societal changes invoked during the pandemic and the extra liquidity dumped into the hands of consumers and businesses.

We determined that 45.2% of our clients scheduled for a December report have experienced this COVID-Echo. The pandemic-induced growth rates are not sustainable, and the trends themselves are at greater risk of shifting from rise to decline. Correlating this input with interest-rate sensitivity will have a lot to do with how adverse the cyclical conditions may become for these clients within the 2023−2025 timeframe.

Management action: Understand that none of the cause-and-effects described for COVID-Echoes are usually immediate. Managers will have time to create strategies and execute tactics to mitigate the impact of these COVID-Echoes.

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