Should You Be Worried About The Bond Yield Curve?


Inverted bond yield curves. Declining global trade statistics. Reduced household spending in the United States and Canada. 

The signs of an impending recession are beginning to grow.

With the global financial markets more integrated than ever before—a fact admonished by 2018’s financial contagion fears—it’s important to understand just how exactly financial indicators like the bond yield curve can affect the TSX Venture.

The Relationship Between Bond Yield Curves And The TSX Venture

The bond yield curve refers to the interest rates of debts with differing maturities, ranging anywhere from 3-month securities to 30-year securities. When this curve inverts, it means that short term interest rates are higher than long term interest rates—a situation that’s far from normal, especially considering that people typically want to get more out of a long term investment than a short term one.

Considering that bond yield curve inversions are historically a predictor of recession within 15 months of their arrival, they tend to send more risk-adverse investors running for the hills…

N.B. It was November 2007—15 months after the 2006 bond yield inversion—when the TSX Venture first began its protracted slide. By the end of 2008, the Venture had eroded over 77%.

As investors begin to believe that the economy is heading into recession and the central banks are about to cut interest rates, investors flee from equities into long-term securities. This is due to the fact that investors are able to lock in higher long-term yield bond rates before central banks cut them later, and because bonds in general are deemed as “safer” investments than equities.

Should economic activity continue to slow, central banks may elect to cut interest rates further—an action that can lead financial institutions to reduce the amount of available credit they lend out, seeing as how it is not in their best interest to lend out money when they are going to earn less on it over time. 

The result? Likely even slower economic activity.

Global Trade Shows Signs Of Weakness

In addition to growing concerns over bond yields, it appears that trade tensions between the U.S. and China may be beginning to put a strain on international trade.

Via Bloomberg,

“Figures published Monday show [global] trade fell 1.8 percent in the three months through January compared with the previous period. That’s the biggest drop since May 2009.”

On the one hand, optimists could argue that the May 2009 drop preceeded the 10-year bull market run we see today. 

On the other, it could be argued that this run was largely attributed to the tech upswing led by companies like IBM, Intel, Hewlett-Packard, and Microsoft. And unfortunately, tech growth is beginning to sputter out.

Via MarketWatch,

“When tech is 20% of the market, and it stalls out, there won’t be another sector to take its place,” [Mark Newton of Newton Advisors] said.

Even cannabis, despite its meteoric growth potential, cannot replace the tech sector. However, it’s not out of the question to say that cannabis could offset some of the tech sector’s stagnancy—especially if the U.S. legalizes marijuana.

Financial Indicators Are Not Foolproof

When looking at indicators like the bond yield curve, it’s important to remember the golden statistical rule: correlation does not imply causation. None of these macroeconomic trends alone—be it bond yield curve inversions or declining household spending—can provide a crystal ball into the future.

In short, while investors should continue to keep a close eye on financial indicators like the bond yield curve, they should also remember that the TSX Venture thrives with risk—and suffers from the skittish.