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Amber Sinha, senior portfolio manager, global equities with CIBC Asset Management.
The inversion in the yield curve recently is currently a fairly popular topic. The reason for that is that the yield curve, and when it inverts, has often been a fairly accurate predictor of recession. As a result, people look to it when they are looking for clues for a recession. We are already in the later innings of the economic cycle. We’ve had an expansion going over more than 10 years. Also, people are certainly a little cautious and an inversion and this yield curve kind of makes people even more cautious.
The yield curve also is a signal of the near-term borrowing costs of the economy. If the yield curve is inverted, it would be inverted when the short-term rates are higher than the long-term rates—which means short-term rates, which affect all types of near-term borrowing, inter-bank borrowing, shows us that there’s stress in that part of the curve. If there’s stress in the short-term borrowing, short-term borrowing and liquidity in the economy is kind of like the lubrication. It’s like the lubricant in the economy. If that kind of dries up, that’s certainly something to watch out for.
In order to confirm a recession, you need more than just the inversion of the yield curve. You will see stresses in the credit market. We don’t see that right now. You will see stresses in the labour market. You don’t see that right now. Unemployment across industries, across demographics is at multi-year, multi-decade low. The labor market doesn’t show the stresses. The credit market doesn’t show stresses.
The manufacturing and industrial piece of the economy: I won’t say it’s stressed right now, but certainly it has shown meaningful slowdown over the last year. Let’s say second half of 2018, first half of 2019, across the board, across geographies, we have seen a slowdown in the manufacturing and industrial economies of the world. Some of what we would look for for a recession, some things are there: the manufacturing slowdown, the inversion of the yield curve, but not everything that you would expect we see right now. Like I said, the labour, credit, a lot of the other parts of the economy continue to do well. The conversion of the yield curve is giving us mixed signals right now, but something to take fairly seriously.
The other issue is that while it’s only giving us mixed signals, it’s not giving us a confirmation. If we even treated the inversion of the yield curve as a confirmation, it could still take anywhere from a few months to a couple of years for the actual recession to set in. I think on an average, it takes 18 months from the inversion of the curve to the onset of the recession. Again, it’s not a set 18 months. It could be three months. It could be two-and-a-half years. Even though we see an inversion, it’s hard to say, “OK, the recession starts in December 2019 or February 2020,” because there is really no set time. To add further confusion or complexity to this answer, we don’t really know that even if a recession is around the corner, when exactly it’s going to happen. For us as investors, as professional investors, we want to participate in the market when things are going up. We wouldn’t want to just look at an inverted yield curve and go to cash and not invest any further.