In his latest note, Eoin Murray, Head of Investment at Hermes Investment Management, discusses the four words he dreads more than anything.
There are plenty of words people in investment use to convince themselves – or others – that things are going to be OK. “This trade can’t fail”, “the market is rational”, “equities always go up”, are prime examples.
But for me, the worst is: “This time it’s different.” Why? It invariably isn’t.
The latest use of this maxim is by people unconcerned about the possibility of the yield curve inverting. The yield curve tracks short and long-term interest rates that fuel the traditional banking model. Short-term rates are usually lower, so it is cheaper for banks to take deposits, and the longer-term rates are higher, so they can issue loans and take a turn on the difference. Any disruption to this system sees the model break down. An inversion of the yield curve occurs when short-term interest rates are higher than long-term ones – it has been a reliable predictor of recessions.
Of course there are many different ways of measuring the steepness of the yield curve, or the term spread. A recent paper by the Federal Reserve Bank of San Francisco suggests that it doesn’t actually matter whether we use 30-year minus 3-month, 10-year minus 2-year, or even attempt to include expectations: