Inverted yield curve in US a key risk for equity markets

ET Intelligence Group: A revival in corporate earnings and improving growth prospects have fuelled the rally in global equity markets. However, a sign of caution is in the air as the US yield curve is headed to the inverted zone.

Interest rates for long-tenure bonds are rising at a slower pace than those for short-term papers. According to market trackers, this may result in lower long-term rates compared with short-term thereby giving an inverted shape to the yield curve.

Historically, such a situation has been a harbinger of a recession with a lag of 10-24 months. This together with tightening by global central banks may bring headwinds for equity markets.


During 1980 and 2000, the inverted yield curve had signalled a rapid approach of stock market peaks. At present, the yield spread between the two-year and 10-year US Treasuries has reduced to a decade low of 58 basis points compared with 125 bps at the beginning of the year.

The two-year bond yield has inched up 57 bps to 1.89 per cent in three months to December, while the 10-year yield rose at a slower pace of 37 bps to 2.48 per cent. Experts predict inverted yield in 2018 and the merging point of the two yields will be at around 2-2.5 per cent.

Inverted yield has been among the most reliable indicators of recession in the past 40 years. During the five previous instances of inverted yield curves, the S&P 500 had reported a double-digit percentage fall on average.