After managing my finances for over 50 years, I came to a realization: significant market movements often stem from overlooked factors. There’s something pretty remarkable going on beneath the surface that many are missing.
In the midst of various tariff crises over recent months, the global yield curve has quietly transformed. Interestingly, the long-term US-based yield curve—which I recently overlooked—has undergone similar changes.
So, what exactly is the yield curve? Well, it’s essentially a graph that displays government bond yields ranging from three months to ten years. When the long-term rates surpass the short ones, the curve slants upward. This is typically considered a “normal” or “straight” curve, which historically signals a bullish market. Conversely, if short-term rates are higher, it appears “inverted.” This inversion often serves as a precursor to economic downturns, although it has proven to be a reliable indicator over time.
This leads to the question: why does it matter? Like indicators on a dashboard, yield curves generally forecast lending behavior among banks. Banks finance long-term loans using short-term deposits. They borrow money at a certain interest rate and lend it out at a higher rate to make a profit. A steep yield curve signals that banks are more likely to lend robustly, stimulating economic growth.
On the flip side, an inverted curve can diminish loan profitability when short-term rates are on top. This typically leads banks to limit their lending, which can stifle GDP growth, since the economy often relies heavily on loans for everything from building inventory to funding expansion.
For decades, the US yield curve has fairly accurately guided investors. However, it seems that, much like a car dashboard, they might have overlooked what’s happening “under the hood,” specifically the lending processes. It worked well—until it didn’t.
After the downturn in global stocks during 2022, the yield curve shifted globally. Fears over an impending recession also surged. While investors hesitated, lending practices continued to evolve. Interestingly enough, despite these fears, GDP was on the rise in the US, Eurozone, and globally. This created a somewhat unusual situation, like a downturn in Germany while other areas expanded. Inventory levels surged, leaving many investors perplexed.
By 2023, the yield curve had flipped, and inventory continued to grow for most of 2024, alongside GDP. Critics, finding this shift puzzling, seemed to view the curve as “broken,” perhaps not fully considering the reasons behind this perception.
On the banking front, many institutions have a substantial amount of low-rate deposits remaining from the COVID-19 years. In 2020, US bank deposits surged by over 20.8% from the prior year, followed by an additional 11.7% rise in 2021. This trend persisted into 2022 and 2023, reflecting broader global patterns.
Consequently, banks haven’t needed to borrow extensively to lend. By raising deposit fees, they aren’t compelled to compete aggressively for deposits. This low-cost reserve has kept lending lucrative, even as rates rise to around 5.5% along with other central banks globally.
Interestingly, this invisible yield curve is now registering a positive reversal, bolstering loan profitability worldwide. This is largely due to reductions in short-term rates—especially abroad—and an increase in long-term rates that, contrary to fears, may actually signify optimism.
As I keep an eye on the global yield curve and its implications for GDP, I noticed a decline of 0.55 percentage points last July. A few months back, it was almost fully inverted. Now? It’s turned positive by about 0.50 points, translating to approximately 1.5 points more in loans over the year. This shift appears bullish and helps explain recent patterns.
The American yield curve has improved somewhat but is still largely flat, with a slight decline of 0.07 percentage points. Meanwhile, the UK’s curve transitioned to a positive 0.35 points from a prior 0.99 points a year ago. On the continent, the shift has been even more pronounced—rising from 0.47 to a remarkable 1.03 points!
The stock market reflects this importance: regionally, MSCI Europe saw an early surge, climbing 22% over the year. It seems that all regions except the US will be in the spotlight this year.
A steep curve seems to favor value stocks (like those in the Eurozone and the UK) over growth stocks, which have dominated in the US. Notably, the Eurozone and UK are projected to lead with financial growth of 52% and 33% respectively, vastly outpacing the US’s 10%. Why? It all boils down to turbocharged bank profits! Moreover, this surge benefits high-value industries in Europe that require loans for expansion.
Crucially, many observers still overlook the yield curve, suggesting that this growing bullish momentum isn’t fully factored into the market yet. So, we can expect continued stock market growth, especially in Europe, the UK, and many emerging markets.
