Market Memo

October 2023 – By Kyle Rohrwasser

Since July of 2022, we have had an inverted yield curve. This is when the 2-year treasury bond has a higher yield than the 10-year treasury bond. Typically, investors expect to receive a higher yield the longer the maturity of the bond. When the yield curve inverts it signals potential economic stress reflecting the uncertainty over the longer time horizon. Since 1978 the yield curve has inverted 6 times and each time a recession has followed. 2008 being the most recent and deepest.

This created an environment where short-term debt has provided a higher yield than long-term debt. Which was encouraging investors to not take on long-duration assets until they are properly compensated for their time of investment risk. With the Federal Reserve recently pausing rate hikes, we have seen the longer-term bond yields rise close to the 2-year treasury yield. The spread of those yields is now under 0.2%. At the peak this spread was over 1%. While the situation is improving, we are not out of the woods yet as the onset of the last 3 recessions followed once the inverted yield curve normalized.

Investors continue to search for clues as to how the next few months may unfold as various signals and indicators are providing conflicting data.  A measure of consumer sentiment declined last month to a remarkably low level, lower than it has been 93% of the time since 1978.  Despite that downbeat consumer, retail sales last month clocked in double what was forecasted.  The consumer remains surprisingly resilient on the surface.  Below the surface, credit card debt is increasing, and the personal savings rate is half of pre-covid levels.  In other words, consumers are spending and borrowing at a potentially unsustainable pace to maintain their lifestyle.  Should the consumer pull back, the economy may go with it.      

At one point in late 2022, a recession was all but assumed, but the consensus has slowly been shifting away from that as the consumer remains more resilient than expected, keeping the economy afloat.  This introduces the potential of a soft landing, the scenario where the economy slows, inflation drops, unemployment is stable, and recession is avoided.  By comparison, a hard landing would trigger a recession as the economy contracts and unemployment increases.   

Which landing we ultimately see will depend on several factors and will likely be revealed over the next quarter or two.     

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