The US yield curve inverted briefly in March, with the 10-year yield falling below its 2-year counterpart. Historically, the 10y-2y yield curve inversions are viewed as recession indicators. That said, our multi asset team, Eastspring Portfolio Advisors (EPA) notes that only 15% of the other combinations of points on the yield curve (e.g. 3-month, 2-year and 10-year) are showing an inversion. In fact, the 10y-3m spread, another good leading indicator of recessions, is currently at ~182 bps1, 25 bps above its long-term average. This suggests that the probability of a US recession is low, for now.
Historically, the 10y-2y spread has on average inverted ~15.9 months before the start of the next recession. Looking at the performance of the Asian markets following a 10y-2y US yield curve inversion, the picture does not appear as gloomy as one would imagine.
In the one month following the six yield curve inversions since 1989, the MSCI Asia ex Japan Index only fell sharply once (1998). The decline was subsequently followed by healthy double-digit gains in the next 12 and 24 months.
Extending the analysis, in the 12 and 24 months following the six yield curve inversions since 1989, the MSCI Asia ex Japan Index too fell only once (2000). Hence, investors sitting out of Asian equities post a US yield curve inversion would have missed out on attractive gains.
Of course, no two episodes in history are identical and investors are currently also grappling with rising inflation, protracted military action in the Ukraine and prolonged sanctions on Russia which risks disrupting strained supply chains further.
Given the complex backdrop, investors would need to be well compensated for taking risks. Cheap valuations can provide some margin of safety and as the market increasingly prices in inflation and growth concerns, there could be pockets of opportunities in the Emerging Markets and China A equities. Investors wanting to retain their exposures in Asian equities but wishing to minimise their potential downside can also consider low volatility strategies.
Performance of MSCI Asia ex Japan following US yield curve inversions
Sources: 1 As of 22 April 2022. Bloomberg.
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