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The Weekly Economic & Market Recap    

July 13, 2018  

The unofficial beginning of the second quarter earnings reporting season kicked off on Friday as several major banks reported second-quarter earnings with mixed results. Trading revenue and loan growth were generally solid, but interest expenses are growing faster than interest income due to the flattening yield curve. The yield differential between the two-year Treasury and the ten-year Treasury continued to compress this week to roughly 25 basis points. This is the tightest spread level since July of 2007, which was just before the Great Recession. Although not an infallible indicator, an inverted Treasury curve has been a solid predictor of a recessionary environment ahead and typically offers investors at least a six-month lead. The persistent decline of the treasury spread over the last 18 months has been disconcerting. In our view, the flattening yield curve is probably not as meaningful a signal as in the past. Due to the distortive effects of quantitative easing across the entire yield curve, but especially regarding intermediate maturities, the flatness of the yield curve is not providing investors with historically correct information. We feel that we are in a typical cycle that has been elongated due to the depths of the last economic recession and impact of central bank action. As the economic cycle continues, we expect the typical pattern of inflation followed by higher long rates, and ultimately over-tightening by the Federal Reserve to play out.

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