The inverted yield curve
Published on September 6, 2019
My daughter asked about the inverted yield curve — I explained negative interest rates

Before she returns to Rhode Island for her third year at Brown University, my daughter Maddie and I took a road trip to see my mother. Shortly after I picked her up, she turned to me and asked: “So, Dad, what do you think about the inverted yield curve?” Maddie has just finished her first internship in the corporate world, and it has attuned her more to today’s financial headlines. Even so, this wasn’t a question I was expecting from my daughter.

The inverted yield curve is an interesting phenomenon, particularly given that it happens so rarely. Generally speaking, the longer an investor lends money, the higher the return. For example, in a normal environment, a one-year Canada Savings Bond may yield a 5% return, whereas a five-year Canada Savings Bond may yield 7.5%. However, in today’s environment, a one-year Canada Savings Bond may be yielding 1.25% at maturity, whereas a five-year Canada Savings Bond may only be yielding 1.2% at maturity.

Although the inverted yield curve is getting all the headlines, given how flat the yield curve is, it’s perhaps not as newsworthy as it seems, even though analysts worry about the correlation between it and recession. What is more worrisome for me is the potential for negative interest rates. When I explained it to Maddie, she found it to be more compelling as well.

I said to Maddie: “Say your brothers asked to borrow $1,000 with an offer to pay a 5% return in 12 months’ time for the privilege. And then I came along and asked to borrow the same $1,000 but was offering -0.25% return. Which investment opportunity would you choose?”

To which my daughter replied almost immediately: “I’d take your offer because I have no idea whether I’d ever see my money from my brothers again!”

“Right!” I replied. Then I said: “Now substitute Italy for your brothers and Germany for me and that is why negative interest rates are of far more interest than the inverted yield curve.” The perceived risk of investing in Italian government bonds has led investors to accept negative interest rates from financially more secure countries like Germany.

Global market volatility

Maddie declared that the world is a mess. However, when we began to think of the events that have happened in her lifetime — 9/11, the war in Afghanistan, the financial crisis — we were able to put today’s crises in perspective.

The unsettling politics in the US, Boris Johnson and Brexit in the UK, Jair Bolsonaro and the Amazon wildfires in Brazil, China’s Xi Jinping and the civil unrest in Hong Kong, not to mention the perennial threats of North Korea, Russia and Iran, the world can feel a bit crazy. It may well get a bit crazier before sanity prevails. Expect the fall to bring more volatility to markets as Canada heads into a federal election cycle, Brexit comes to pass with or without a deal, the 2020 US election cycle heats up, and China continues to flex its muscles at home and abroad.

This too shall pass

What we need to remember is that this too shall pass. I was reminded of this as my son begins his path in the investment world. Forty years ago, his grandfather was in the early stages of his career in the industry. At the time, 30-year Government of Canada Bonds were paying yields of over 18%. Today, Government of Canada Bond rates are below 2%.

The pendulum swings. Companies adjust. People adjust. And we keep moving forward.

No one likes the rhetoric coming from Washington, London or Beijing. It’s unnerving. Everything around us is changing. But the one constant we can count on is that over the long term, the economy will continue to grow.

Historically, fall is a tough time for markets, and we expect it to be so again. It’s important to remember during these times that the best time to buy is when the bears come out of hibernation.

Stephen and Steven head to NYC for an investor event

With an eye to buy for our clients, for the first time Steven Wippersteg and I will be traveling together to New York in September for Brookfield’s 2019 Investor Day. Many of our clients already hold investments in the Brookfield portfolio of assets.

We look forward to gaining a more global perspective and to hearing a bit more about the recent investments they’ve made in Genworth Canada and Ouro Verde, as well as their plans for future investments as they grow their portfolio.

Stay tuned. We’ll let you know what we learn in next month’s newsletter.

Sincerely,

Stephen Sisokin

President

Information is General Only. This newsletter is for general information purposes only. It is not intended as specific investment, financial, legal or tax advice and you should not rely on it as such. This newsletter does not constitute the official version of Howard, Barclay & Associates Ltd.'s disclosure documents and may not always be the most current. This newsletter and information contained therein is provided “as is”. Howard, Barclay & Associates Ltd. does not warrant the accuracy, adequacy, timeliness, or completeness of this newsletter and information contained therein, and disclaims liability for any errors or omissions.

« Go Back