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What is an inverted yield curve and what does it mean for SA?

There could be a global recession on the horizon.
Within the South African context, real rates stand out as an investment opportunity compared with other emerging market peers and the low-to-negative developed market bond yields.mage: Shutterstock

Global growth has been slowing throughout most of 2019. Although the US economy has achieved full employment and consumer-related data is still robust, fears it will slow below potential growth have been increasing across financial markets, largely due to trade tensions between the US and China.

Europe has its own housekeeping issues and continues to face persistently low growth and inflation, which, during 2019, nudged the European Central Bank to reintroduce a more open-ended quantitative easing programme and cut deposit rates further into negative territory. As a result, we now have approximately US$16 trillion of bonds globally with a negative yield and some markets (like the US) are periodically showing an inverted yield curve. The inversion of the US yield curve has recently sparked debate across the investment industry of a looming recession. History has shown us that recessions post-World War II were preceded or signalled by a yield curve inversion.

Global markets: what an inverted yield curve means

The yield curve

The yield curve is a graphical representation of prevailing market interest rates (yields) for bonds of different maturities, usually government bonds. Shorter-dated bonds tend to reflect government’s current monetary policy stance, while longer-maturity bonds tend to reflect market expectations of future inflation and the resulting path of interest rates.

Yield curve inversion prior to recession?

To illustrate why the yield curve usually inverts before recession, let’s consider the example of the yield curve representing monetary policy expectations. If market participants expect growth to slow down in the near future, they start pricing in higher probabilities of upcoming reductions in interest rates by Central Banks to support economic growth. This results in long-dated bond yields decreasing by a higher margin than short-dated bonds – so the yield curve flattens.

The extent to which the interest rates fall is a function of the length and severity of economic slowdown expected by market participants. If a recession is anticipated, participants would price in more pronounced interest rate cuts by central bankers using countercyclical monetary policy to stimulate the economy – cutting interest rates to encourage investors and businesses to borrow for growth. In this case long-maturity bond yields can decrease to such an extent that they fall below short-maturity bonds, the phenomenon called yield curve inversion.

Historically, an inverted yield curve successfully signalled a recession six to 18 months before it happened, justifying recent debates around whether a recession in the US is looming. US 10-year bonds (the longer dated government bonds) are trading at 1.7% as at 30 September.

How does this impact local investors?

Whether or not a recession unfolds in the short term, recession fears in global markets increase volatility levels. Volatility leads to risk aversion, causing investors to sell off risk assets such as equities and emerging market currencies and debt. Volatility also leads to a flight to quality as investors reallocate capital to safe-haven assets such as developed market government bonds. This explains the rally we recently experienced in these assets, where some of these government bond yields decreased (prices increased) to an extent that even the longest-dated (30-year) government bond yields were negative. This means an investor holding these negative-yielding bonds to maturity, is effectively paying the government to invest money instead of the other way around.

Investors do however tend to balance this need for safety with a search for positive yield elsewhere. Emerging market bonds tend to offer attractive positive yields, and so the extent of any sell-off of these assets as recession fears mount is limited. Instead, we may experience capital flows into these markets.

As an emerging market, South Africa offers compelling bond yields, with nominal 30-year bond yield hovering around 10%, effectively delivering real return of 5.5% (considering current inflation rates). Given the Sarb’s credibility and the market view that our central bank will keep longer term inflation around the 4.5% level, these real rates stand out as an investment opportunity compared with SA’s emerging market peers and the low-to-negative developed market bond yields.

There are local risks around the strained fiscus and persistently low growth which could lead to ratings downgrades (although our view is that this is unlikely) and a potential sell-off in bond yields. However, we believe the accommodative global monetary environment and relative valuation of SA bonds provide some potential protection against a major sell-off in our market.

Sylvester Kobo, fixed income portfolio manager at Stanlib.


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If enough people believe that the inverted yield curve is the precursor to a recession then it becomes a self fulfilling prophecy. They will act according to their beliefs and thereby what they fear becomes a reality. A wonderful situation awaits the contrarians.

I concur Leon. If everyone (‘the markets’) is anticipating a recession, most would’ve take new positions / rebalanced their positions already.

But it then could mean we’re already in a self-imposed global recession(?)

Was it not Wayne McCurrie (FNB Wealth) on BDTV that said, after same question was posed, something like “the conditions leading to a global recession is not there yet”.

He stated that based on historic data “global interest rates & inflation was running very high prior entering into previous recessions, as indicated by inverse yield curve”.

“We don’t have high global interest rates currently”. The conditions are different.

(interestingly, IF global markets deteriorates further towards a recession, many developed countries have little scope to lower interest rates to provide relief. How far into negative rates can some nations go?)

so the big Q: if you have lightened out of mostly US equities and sitting with dollars, where do you park it while you wait for the big share correction?

I am too afraid of what the Runt normally does in a global crisis to come here for the high yield.

What will China bonds do? They offer about 4% and probably their currency should appreciate over looong term against dollar and euro?

Buy New Gold or similar US ETF. After the crash, cash in gold and buy dirt-cheap blue-chips.

The US yield curve has moved lower and inverted in the belly (3-5 years) in response to very poor industrial production numbers (Germany) very poor trade numbers (Germany, South Korea, Japan and China), relatively poor (to prior years) GDP numbers in China and uneven data coming out of the US. Yield curve inversion has a very strong record of foretelling a recession since WWII. That is why it is so powerful an indicator.RSA medium-term yields (5-10 years) have remained nominally much the same over the period when 10 year yields in the US went from 3,20% to 1.40’ish in August.

In my view that is a very realistic assessment of the growing fiscal deterioration risk in SA government finances. If Govt fail to face down the crisis in SAA, the first domino, then in my view bonds will even at these levels are a sell. SA equities are also starting to look vulnerable, particularly in the context of serially record highs in the US, as an example.

There is only one certainly in my opinion. SA will be vulnerable to whatever follows in developed markets – a combination of idiosyncratic SA risk factors and the openness of the economy and financial markets to the flow of funds. We are going to be tested methinks.

There is a direct cause and effect relationship between the level of the yield curve and the economy, as represented in the share market. Companies have to keep on rolling their credit facilities on an annual basis. Business operations depend on the liquidy, or availability, of credit. When credit-extension dries up, then businesses run out of cash flow and are forced to retrench workers and to scale down operations.

Banks are in the business of borrowing short-term and lending long-term. They trade, or sell, the positive yield curve. When the yield curve inverts, then their input costs exceed the value of their “merchandise”. They simply stop selling loans. The economy runs out of liquidity. They call this a recession, or if it forces banks and businesses to deleverage, it is a depression.

The yield curve inverts because the Fed is out of touch with reality. The Fed tapers while the market is in need of liquidity. The Fed causes the inversion of the yield curve, and therefore, the Fed causes the recession.

@Sensei…one of the few to cotton on to who the Big Daddy of the stock markets really is

Yes, please rewind to the beginning, and research who pulled the rug and purposefully initiated the first major stock market ‘crash’ in 1929, and see the rolling template from there

Oh, you thought that was just ‘market dynamics’ ….?…..

The reality is the globalist elite, via the Federal Reserve, IBS, and their spider web of central banks operating in every country of the world [ except for only Iran and Syria, and we know how those 2 naughty boys are going to be punished for not complying, as they are next on the war list ] control every single aspect of finance as we know it today……right down to the binary 0’s and 1’s of your bank account

Wars are initiated by these globalists, Presidents are assassinated, countries are punished, regime changes are orchestrated, journalists are eliminated – these powerful entities answer to no one …even the immensely powerful Royal Family fall under the Rothchilds and their henchmen

Anyone who has not read E Griffin’s ‘The Creature from Jekyll Island’ and how the Fed Res was established, is oblivious to the machinations of the market and the elite who pull the strings, and the knee jerk reaction will be to classify this as ‘conspiracy theory’ [ that CIA coined term to dismiss any form of critical thinking and maintain the mainstream ideology ]

Nothing, but nothing, passes under their guard without their vetting

If you think the markets are ‘free’, it might be better to stay blue pilled, and believe the official narrative that 9/11 was orchestrated by some cave dwellers armed with box cutters, that vaccines are ‘good’ for you, that the moon landing was ‘real’, and that government has your best interests at heart

Good luck out there !

End of comments.





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