Ignoring the yield curve gave it power. Now is the time to pay attention

Irish Independent

18 hours ago

They rarely giving false signals – like a handy instrument on your car's dash. Until 2022, when the recession they predicted didn't come.
Now, like a broken tyre pressure gauge in an old banger, they are broadly ignored – giving the global yield curve's recent re-steepening big, bullish and growthy power. Let me explain why this tool 'broke' – and what it is important now for 2025 trends.
First, consumer finance and capital markets move most on what isn't noticed; a fundamental truth that reigned repeatedly during my 50-plus years running money. Whatever isn't seen or watched, markets haven't fully priced – giving it fuel.
As background, yield curves graph a country's government bond rates, short-term versus long-term, left to right (think three-month yields all the way to 10-year yields or longer). When long rates exceed short, the 'curve' slopes up to the right.
Strongly upward-sloping, 'steep', curves were classically deemed bullish. Conversely, 'inverted' curves (short rates topping long) generally – but imperfectly – predicted recession, tough times.
Why? Yield curves successfully predicted banks' future eagerness to lend – fuelling consumer and corporate lending, economies and stocks. Banks' basic business is borrowing short-term deposits to fund longer-term loans, pocketing the spread.
Steeper curves meant lower funding costs and higher loan revenue. So, banks lent eagerly, spurring growth. With inverted curves, loan profitability shrivelled, credit froze, stocks imploded … and soon, recession followed.
For ages, seers watched the curve, hawk-like – primarily America's curve, given its historic financial dominance. Like eyeing a car's instrument panel, many simply assumed America's curve reflected reality – because it long had. But they ignored what was happening under the hood: actual lending.
It worked until it didn't. In late 2022, yield curves inverted globally, leading almost everyone to expect recession and ongoing dismal stock returns.
Yes, Ireland weathered a short 2023 'recession' based on skewed GDP data – yet multinationals' slumping exports largely underpinned that. Modified domestic demand, a more accurate metric of your economy, grew despite Ireland's inverted curve. So did European GDP, the US and world – while stocks in those regions rebounded bigtime. Inversion, GDP growth and global bull markets unexpectedly paralleled through 2023 and most of 2024.
Initially, pundits scratched their heads, questioning the curve's false warnings. Eventually, most simply ignored the 'broken' curve. They still do. That gives its recent, silent re-steepening power.
But why did it 'break?' Simple: Banks accumulated gargantuan low-cost deposits from Covid policy responses and lockdowns.
In 2020, low-cost US bank deposits ballooned 20.8pc and spiked another 11.7pc in 2021 – remaining elevated through 2022 and beyond, echoing global trends. Irish household and non-financial corporate deposits grew 14.6pc and 10.7pc those two years.
Hence, banks' deposit costs remained firmly below 1pc globally despite central banks everywhere hiking rates trying to kill inflation (which they, themselves, caused by spiking money supply amid lockdowns). With funding costs low, bank lending persisted. So the yield curve's legendary predictive powers faded.
Recently, European, Irish and other nations' curves silently started steepening. Partly, that came as the ECB and Fed cut short-term rates (which, unlike 2022, actually helped banks and still does, by further reducing their deposit costs) – and partly because long-term rates rose (which most investors wrongly dreaded).
Given money flows relatively freely globally, I have long calculated a GDP-weighted global yield curve. A year ago, global 10-year sovereign bond yields were -0.57 percentage point (ppt) below 3-month yields – deeply inverted.
Now? That spread flipped positive 0.60 ppt – nearly a 1.2 ppt shift. It isn't all-powerful but it is bullish and economically growthy – helping consumers and explaining recent stock market leadership trends by category and region.
Steepening came mostly outside America. The US spread is 0.15 ppt now – basically flat.
The global yield curve's steepening remains obscure because most investors fixate excessively on America. Ireland's curve shifted from -0.77 ppt inverted last year to positive 1.01 ppts – a 1.8 ppt steepening. Developed Europe shifted from -0.63 ppt to 1.01 ppts, a similar, 1.6 ppt shift. That matters – particularly because it is so unnoticed.
As 2025 persists, Irish consumers can expect to see banks increasingly prone to render them loans, particularly home mortgages. That means you. Ditto for even semi-creditworthy corporations.
Regionally, where curves steepened most, stocks shine brighter. It is partly why I told you in February European stocks would lead the world this year. The MSCI Europe neared new all-time highs in May and June.
The Iseq hit new highs in both. Globally, non-US stocks, led by Europe, outshine America's year-to-date – by double digits. No coincidence.
Steepening yield curves also boost lower-growth oriented, cheaper value stocks – which dominate Europe and Ireland – relative to growth stocks, which dominate America. For example, European bank stocks are up 34pc year-to-date, smashing US Tech, which is down -9.1pc. Why?
In part, because the curve shift boosted banks' profit outlook. Or consider Europe's value-orientated industrials sector – up 17.7pc year-to-date. Heavy industry loves more lending – needing it to fuel growth and earnings.
That few see or celebrate the yield curve's re-steepening means its power isn't spent. Now, that steepening alone won't dictate markets' direction. But its stealthiness provides it ongoing power – and shows you 2025's European and value-orientated stock leadership will persist.
Ken Fisher is founder and executive chairman of Fisher Investments. In Ireland, he writes exclusively for the 'Sunday Independent'