Evercore Warns of Rising Yield-Curve Inversion Risk Amid Fed Rate Hikes

TLDR

• Evercore ISI says risk of a yield-curve inversion is rising as the Fed’s rate hikes and high long-term yields squeeze the gap between short and long-term Treasury bonds.
• The 2-year/10-year Treasury spread has flattened, similar to the pattern seen before the 2022 inversion.
• Historically, inversions have led recessions by an average of 15 months, but the timing has ranged from 5 months to 34 months.
• Not every inversion has led to a recession, with 1998 and 2022 being examples where the economy avoided contraction.
• Evercore still holds long positions in AI-related sectors like tech, communication services and consumer discretionary stocks.

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Evercore ISI says the odds of a U.S. yield-curve inversion are increasing. This comes as the Federal Reserve keeps raising rates and long-term Treasury yields stay elevated.

The firm pointed to the 2-year and 10-year Treasury spread. It has flattened in a way that resembles the setup before the 2022 inversion.

An inverted yield curve happens when short-term bond yields rise above long-term ones. It is often seen as a warning sign for the economy.

What History Shows About Inversions

Evercore said inversions have historically come before recessions. On average, the gap between an inversion and a recession has been about 15 months.

That gap has varied widely though. After the 2019 inversion, a recession followed in just 5 months. After the 1978 inversion, it took 34 months.

The firm also noted two exceptions. In 1998 and 2022, the economy avoided a recession even after the curve inverted.

Evercore said inversions have often been followed by short-term stock market swings and sideways trading. But they have not always ended long bull markets.

The firm used 1998 as an example. A brief inversion that year was followed by a 22% drop in stocks. Still, the broader bull market kept going afterward.

Evercore Keeps Its AI Stock Bets

Despite the warning signs, Evercore said it is keeping its long positions in AI-related stocks. That includes companies in technology, communication services and consumer discretionary sectors.

The firm said there is not yet clear proof that higher energy prices or Treasury yields are hurting the economy.

Evercore also pointed to a pattern in how stocks perform around inversions. Tech and Nasdaq-listed stocks have tended to do well in the lead-up to an inversion.

After an inversion, sectors like health care, communication services and consumer staples have often performed better. This tends to happen as investors get more cautious.

Because of this, Evercore is recommending a partial defensive shift. This does not mean giving up on AI stocks entirely.

The firm suggested investors keep flexibility while market swings remain low. It also said stocks with “negative beta,” which tend to move opposite to the broader market, could act as a hedge.

Evercore said current economic data still looks healthy. Corporate surveys remain in expansion territory. Jobless claims are low, and credit spreads remain steady.

Still, the firm flagged two pressure points. Oil prices are near $95 a barrel. The 10-year Treasury yield is above 5%.