Even if you don't usually pay attention to interest rates, information presented on a new installment of Futures Measures is very compelling, and worth reviewing when your schedule allows.

The focus of the show is the yield curve, and in particular "yield curve inversions." The yield curve represents a timeline of interest rates across a range of different maturities, and is typically presented in chart form.

A "normal" yield curve is usually described by a gradually rising line going from left to right on the chart - meaning interest rates are increasing along with the length of maturity. Alternatively, an "interest rate inversion" occurs when short term rates climb higher than longer-term rates - even if only for a brief period.

As noted on Futures Measures, a yield curve inversion occurred during the first week of December 2018 - the first observed instance since 2007.

Specifically, it was 2-year Treasury yields that rose above both 3 and 5-year yields. Yield curve spreads are computed by subtracting the longer-dated maturity from the short-dated maturity. Because 2-year yields were higher than 3 and 5-year yields, those calculations both netted negative numbers (the definition of an “inverted” yield curve) for the first time in over a decade.

One reason that yield curve inversions are followed so closely is because they often serve as a signal for possible changes in the economy, as detailed in the bullets below:

What can yield curve inversions mean for the economy and stock market?

  • Often there is no immediate reaction observed

  • Poor economic data can follow at some point during/after an inversion

  • Economic downturns and corrections in the stock market may also materialize

Just a couple months ago, the hosts of Futures Measures (Pete Mulmat and Frank Kaberna) featured the yield curve on one of their shows, and indicated that an inversion might be on the horizon. As of early December, that prediction has now come to pass.

However, it’s critical to note that the spread between the 2-year and 10-year yields has not yet inverted - meaning 10-year yields are still higher than 2-year yields. This is an important relationship to monitor going forward, because each of the last 7 recessions has been predicated by an inversion of the 2-10 spread.

The graphic below highlights several previous yield curve inversions involving the 2-10 spread - with a price chart of SPY overlaid over these instances:

Inversion

While the above information is certainly valuable, one must also keep in mind that the duration of the 2-10 inversion is also an important factor. Research conducted by tastytrade shows that 2-10 yields inverted for only a single day during 1994 and 1998, and no recession materialized in the aftermath.

On this episode of Futures Measures, the hosts also discuss why this week’s meeting of the Federal Reserve could prove to be an important one for the 2-10 spread.

We hope you’ll take the time to review the complete episode of Futures Measures focusing on the recent inversion in the yield curve (2-3 spreads and 2-5 spreads) when your schedule allows. If you want to learn more about trading the yield curve, you can also tune into this previous installment of The Ryan & Beef Show.

If you have any questions about any of this material, don’t hesitate to leave a message in the space below, or reach out directly to @tastytrade on Twitter or send an email to support@tastytrade.com.

We look forward to hearing from you!


Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.  


Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.