Week in Review: Is an Economic Growth Slowdown Forthcoming?

Week in Review – Friday, March 10, 2023

Is an economic growth slowdown forthcoming?

Fed reserve Powell’s Remarks create the largest yield inversion in 40 Years

This past week, Federal Reserve Chairman Powell spoke before the Senate Banking Committee and in his prepared remarks suggested that the terminal rate “is likely to be higher than previously anticipated” in light of the recent growth and inflation data. Chair Powell also noted that the FOMC would be “prepared to increase the pace of rate hikes” if the data suggests a faster pace is warranted. Following the release of his prepared testimony, equity markets pulled back and the two-year to ten-year treasury spread widened its inversion.

In normal times, longer-dated bonds typically yield more than shorter-dated issues, partly owing to the risk associated with holding bonds over a longer period. An inverted yield curve occurs when yields on short-term bonds rise above the yields on longer-term bonds of the same credit quality. While two-year Treasuries have been trading at higher yields than ten-year debt since July, this week saw the inversion increase to over 1% or at its widest level since 1981.

The gray bars throughout the chart indicate the past U.S. recessions since 1980. A quick look at the treasury yield spread (10Y-2Y) suggests that historically, an economic recession generally follows once the yield spread drops below 0% with a lag of 18 months on average.

While the potential for recession is a significant concern for corporate earnings and credit, inflationary pressures remain high and well above the long-term target of 2.0% supporting the resolve of the Federal Reserve to raise short term interest rates. This has created an opportunity for investors to benefit from the 5% plus yield afforded in short-term treasuries. However, longer duration bonds and equities of quality companies which have seen multiple compression are also more attractive, albeit the benefits may be more volatile and deferred until signs of inflation being vanquished are well established and a line of sight to the other side of a recession is clear.

While the chance of a recession is still unknown, the steep inversion of the yield curve is indicative that an economic growth slowdown will be forthcoming. On the one hand the impact on the market will likely be elevated volatility and near-term risk. On the other hand, the risk has already been well telegraphed and likely priced at least in part by the market, providing potentially attractive entry points for long term investors. We believe, a balanced approach focused on quality equities, bonds, and alternatives should provide favorable long term investment opportunity – with attractive options for shorter term investments to fund the liquidity bucket.

Important Disclosures:

The preceding information is for general educational purposes only. It is not intended to be investment advice, and is not specific to any individual’s personal situation. Any decision about investing should be undertaken only after careful consideration of the investment’s risks, costs, liquidity or lack thereof, and the investor’s timeframe.

Investment Advice offered through Pallas Capital Advisors, LLC, a registered investment advisor. Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product referred to directly or indirectly in this newsletter will be profitable, or equal any corresponding indicated historical performance level(s)
Investment Advice offered through Pallas Capital Advisors, LLC, a registered investment advisor.

Mark A. Bogar, CFA^®, CAIA^®
Chief Investment Officer
Pallas Capital Advisors

Stephen Kylander
Senior Portfolio Manager
Pallas Capital Advisors

The information contained herein is for informational purposes only, is not personalized investment advice and should not be construed as a recommendation to purchase or sell any particular security, sector or strategy to any individual person or entity. The decision to review or consider the purchase or sale of any security, sector or strategy mentioned should not be undertaken without consideration of your personal financial information, investment objectives and risk tolerance with your financial professional. Past performance should not be considered as an indicator of future results.

Investment Advice offered through Pallas Capital Advisors LLC, a registered investment advisor.

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