An important event happened this week, which might very well signal that things are about to get a lot worse before they get better.

For more than 50 years one of the most powerful indicators of the health of the economy has been the US yield curve.

The yield curve is the difference in US rates between the short and longer-dated bonds. This week the yield on the 3-month t-bills pushed higher than the yield on the 10-year note.

That is known as being ‘inverted’ and it is effectively telling us that there is clearly more demand for long-term bonds than the shorter-dated bonds.

At the moment there is a higher return for short-dated bonds than long ones. Indicating there isn’t any confidence in what the economy is doing at the moment and there is clearly demand for bonds over other instruments going forward.

An inverted curve is a big signal that a recession is looming. Over the last 50 years, the yield curve has inverted every time ahead of a recession. There was one occasion when it was a false signal.

Once the curve has inverted, it has taken anywhere from 12 to 24 months to fall into a recession. Let’s remember that a recession is simply two periods of negative economic growth.

So for investors out there, there is need for caution. With growth looking like it might come under pressure in the US, we need to think about what that might mean for interest rates going forward and in turn the USD. While stocks might also be stifled under the weight of a shrinking economy.

Things to watch:

• Downwards pressure on the USD
• FOMC unable to raise rates
• Stocks getting pressured by lack of growth