Latest / The Bear Market Podcast with Fexingo: Surviving Downturns, Buying the Dip, and Long-Term Resilience / Why the Yield Curve Un-inverting Is Actually Bearish
Transcript
- Lucas: So the yield curve has un-inverted. Ten-year Treasury at 4.63 percent, the 2-year at 4.26 — that's a spread of 37 basis points. On the surface, it looks like the all-clear. The curve is normal again. But historically, un-inverting from a deep inversion is often where the trouble starts. Luna: Right, I remember you mentioning that the 1990, 2001, and 2008 recessions all began after the curve had steepened back into positive territory. Not during the inversion itself. Lucas: Exactly. The inversion is the warning — it means the market expects future rate cuts because growth is deteriorating. But the actual recession often doesn't hit until the Fed starts cutting and the curve re-steepens. That's when the economy is already rolling over. Luna: So we've had 26 months of inversion — the longest stretch since the 1970s. And now that it's finally positive, the market's cheering? But you're saying that could be premature. Lucas: Precisely. Let's look at what's happening under the hood. The 10-year real yield — that's the nominal yield minus breakeven inflation — is now above 2 percent. That's a restrictive level. It means the bond market is effectively tightening financial conditions even if the Fed holds rates steady. Meanwhile, the S&P 500 is at 7,499 — down about half a percent in the last five days, but still near all-time highs. And the VIX has dropped to 16.64, down 11 percent over the same period. That's complacency. Luna: So the VIX is saying 'risk off, everything's fine,' but the yield curve is saying 'watch out.' That's a divergence. Lucas: It is. And it's not the only one. Look at the 30-year Treasury yield — 5.13 percent. That's up from 5.11 a day ago, and it's been creeping higher for weeks. The long end is pricing in term premium — compensation for uncertainty about inflation and fiscal deficits. That's not a soft-landing signal. That's a 'we're not out of the woods' signal. Luna: So if I'm a dip buyer looking at this market — S&P near 7,500, VIX low, curve normalizing — the typical playbook would be to buy the pullback. But you're saying this steepening could actually be a trap. Lucas: I think it warrants caution. Let's go back to 2001. The curve inverted in early 2000, then steepened through late 2000 into early 2001. The recession started in March 2001. The S&P 500 peaked in March 2000 and fell another 20 percent after the curve un-inverted. Similarly, in 2008, the curve inverted in 2006, steepened in 2007, and the recession started in December 2007. The market didn't bottom until March 2009. Luna: So the market often falls further after the curve normalizes. Because the bad news is still coming. Lucas: Right. The inversion tells you the market is pricing in a slowdown. The steepening — when the long end rises faster than the short end — tells you that the slowdown is materializing. And that's when earnings start to get cut, and valuations compress. Luna: Now, the current steepening has a slightly different flavor. The short end isn't falling much — the 2-year is at 4.26, up from 4.21 the day before. So it's not just the Fed cutting. It's the long end rising on its own. That's more about term premium and inflation expectations. Lucas: Exactly. This is a bear steepening, not a bull steepening. In a bull steepening, the short end falls faster because the Fed is cutting aggressively. That's typically good for risk assets. But a bear steepening — where the long end rises because of inflation or deficit concerns — that's historically been a headwind for stocks. Luna: And we're seeing that — the Dow is down 0.6 percent in five days, the NASDAQ down 0.7 percent. Nothing catastrophic, but the trend is down. Lucas: Right. And the Russell 2000 is down half a percent. Small caps are often the canary in the coal mine for economic weakness. They're more sensitive to rising long-term rates because they carry more debt. Luna: So where does that leave the investor who's sitting on cash, waiting to buy the dip? Is this the dip, or is the dip still ahead? Lucas: That's the million-dollar question. I think the key is to look at what the bond market is pricing in. The 10-year real yield above 2 percent suggests that the neutral rate — the rate that neither stimulates nor restricts — is higher than the Fed's current 4.25 to 4.50 percent target range. That implies the Fed is actually still accommodative, not restrictive. Which means they might need to hike more, or hold longer, to get the economy to slow. Luna: So the market is doing the Fed's job for them — long rates rising, tightening conditions. But if the economy doesn't slow, then the Fed may have to act again. That's not a great setup for risk assets. Lucas: Exactly. And we saw that in the last few weeks — the 10-year yield went from around 4.4 to 4.63, and stocks have edged lower. The market is starting to listen to the bond market. But the VIX at 16.64 says there's still a lot of complacency. If the bond market continues to sell off, that could change quickly. Luna: There's also the headline from John Paulson yesterday — he said we're in the early stages of a long-term gold bull market. That fits with the narrative of real yields staying high and inflation sticky. Gold tends to do well when real rates are elevated and the dollar is under pressure. Lucas: Paulson's been right about gold before — he famously shorted subprime in 2007. But his track record isn't perfect. Still, the fact that a major hedge fund manager is talking about gold as a long-term play reinforces the idea that the bond market's signal isn't noise. It's a structural shift. Luna: So if someone is listening and thinking about their portfolio — maybe they have a 60/40 stock-bond allocation — what's the takeaway? Do you rotate into bonds? Do you stay in stocks? Lucas: I'd say it's a time to be thoughtful about duration. If you're in long-term bonds, the 30-year at 5.13 percent is attractive, but the risk is that rates go higher. If you're in stocks, focus on quality — companies with strong balance sheets, pricing power, and the ability to pass on costs. The kind of companies that can withstand a margin squeeze. And be careful with high-beta names that rallied into the curve un-inversion. They could be the most vulnerable. Luna: So the curve is telling us that the easy gains from the 'buy the dip' playbook might be behind us. At least for now. Lucas: I think that's right. And if the real yield stays above 2 percent, the equity risk premium — the extra return you get from stocks over bonds — shrinks. That makes bonds more competitive. It's not a crash call, but it's a reason to be selective. Luna: It's interesting — if today's episode helped you think about the yield curve in a different way, maybe gave you a framework for your next move, that's exactly the kind of conversation we try to have here. And the way these stay ad-free and independent is through listener support. If you found value in it, you can head to buy me a coffee dot com slash fexingo — no pressure, just a way to keep the lights on. Lucas: Absolutely. Every bit helps us keep doing the deep dives without chasing clicks. So thanks for considering it. Luna: So back to the curve — one more thing. The 3-month Treasury is at 3.87 percent, which is still below the 10-year. So the entire curve is now positively sloped. But the 3-month to 10-year spread was inverted for a long time too. It only recently turned positive. That's another layer to watch. Lucas: Good point. The 3-month to 10-year spread is often seen as the most reliable recession indicator — it's the one that Campbell Harvey highlighted. It inverted in late 2022 and only un-inverted a few months ago. Historically, recessions have followed 6 to 18 months after that inversion ends. So we're still in that window. Luna: So the next six to twelve months could be telling. If the economy holds up, maybe this time is different. But if it weakens, the bond market's current message will have been correct. Lucas: Exactly. And that's why I think the most important thing for investors right now is humility. The yield curve is not a perfect timing tool, but its track record is strong. And when the VIX is low and the curve is steepening, it's worth paying attention. Luna: Alright, Lucas. So the takeaway: the un-inverted curve is not the all-clear — it's a shift in the market's message. And the next few months will tell us whether that message is a soft landing or a delayed hangover. Lucas: Well said. Thanks for the conversation, Luna. Luna: Thanks, Lucas. And thanks to our listeners for tuning in.