Markets’ biggest moves come from what isn’t noticed. That fundamental truth has reigned repeatedly during my 50-plus years of managing money. Variations in widely watched things can wiggle stocks somewhat in the short term. But major moves and longer? Not really. It is the things that investors haven’t noticed - and so haven’t been priced in - that hold the potential to juice markets.
A large, largely unseen bullish force is the global yield curve’s silent re-steepening.
Yield curves – ignored recently, for reasons I will explain – were long near sacred. They graph a country’s government bond rates, short-term versus long-term, spanning three-month yields on the left to 10-year yields (or longer) on the right.
When long rates exceed short, the “curve” slopes upward to the right. Strongly upward-sloping or “steep” yield curves were classically deemed bullish. Conversely, “inverted” curves (short rates topping long ones) generally – but imperfectly – predicted recession.
Why? The curves predicted banks’ profitability and, thus, their eagerness to lend, which in turn fueled economies and stocks. Banks’ basic business is borrowing short-term deposits to fund longer-term loans, pocketing the spread. Steep curves meant lower funding costs and higher loan revenue. So, banks lent eagerly, spurring growth. With inverted curves, loan profitability shriveled, credit froze, stocks imploded … and GDP did, too.
The curve rarely gave false signals. It was watched hawk-like – primarily the U.S. curve, given America’s global financial dominance. Like driving a car, eyeing its instrument panel, many simply assumed America’s curve reflected reality – because it long had. They ignored what was happening under the hood: bank lending.
It worked until it didn’t. In late 2022, after global stocks’ minor bear market, yield curves inverted — and started flashing false signals, like a broken tire pressure gauge.
That inversion made almost everyone expect recession and continuing dismal stock returns. But Canadian, U.S. and world GDP kept growing overall, while the TSX, S&P 500 and MSCI World indexes rebounded big time. That inversion and global bull market ran side-by-side through 2023 and most of 2024.
Initially, pundits head-scratchingly questioned the curve’s false warnings. But, eventually, most simply ignored the “broken” curve. They still do. That gives its recent, silent re-steepening power.
Why did it “break”? Simple: Banks accumulated oceans of super low-cost deposits from COVID policy responses and lockdowns. In 2020, U.S. bank deposits ballooned 20.8 per cent year-over-year and spiked another 11.7 per cent in 2021 – and remained elevated through 2022 and beyond, echoing global trends. Canadian deposits spiked even more – up 37.2 per cent in 2020 and 13.2 per cent in 2022.
Hence, banks’ deposit costs remained firmly below 1 per cent globally despite central banks everywhere raising rates as they tried to fight the massive inflation that they, themselves, caused by boosting money supply amid lockdowns. The scenario was unprecedented! Lending persisted. So, the yield curve’s legendary predictive power faded. All 2023. Most of 2024.
Then, ignored, European, Canadian and other countries’ curves silently started steepening. Partly, that came as the Bank of Canada, the European Central Bank and the U.S. Fed cut short-term rates – which, unlike 2022, now actually helped banks by pushing their deposit costs even lower – 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. It just works better in predicting the economy, future bank lending and market direction. Last June, global 10-year sovereign bond yields were minus-0.85 percentage point (ppt) below three-month yields— deeply inverted! Now? That spread flipped positive 0.37 ppt — a shift of more than 1.2 ppt. It doesn’t singularly rule out a recession or bear market. But it really helps – and explains recent leadership trends by category and region.
The steepening came mostly outside America. Its curve is basically flat now. The global yield curve’s steepening remains obscure because most investors fixate excessively on America. Canada’s curve shifted from minus-1.26 ppts last June to positive 0.54 ppt — a steepening of 1.8 ppt! Developed Europe shifted from minus-0.76 ppt to 1.02 ppts, another shift of 1.8 ppt. That matters – particularly because it is so unnoticed.
Regionally, where it improved most, stocks do better. The MSCI Europe neared new all-time highs this month. The TSX hit new highs throughout mid-May. Globally, non-U.S. stocks outshine America’s year-to-date, which wiggle wildly sideways. No coincidence.
Steepening yield curves boost lower-growth, cheaper value stocks — which dominate Europe (and Canada, albeit less so) — relative to growth stocks, which dominate America. For example, MSCI Europe’s Banks industry group rose 38.8 per cent this year to date, smashing the S&P 500 Tech sector, which is down. Why? In part, because the curve shift boosted banks’ profit outlook.
Consider MSCI Europe’s value-oriented Industrials and Consumer Discretionary sectors — up 21.1 per cent and 4.6 per cent, respectively, year-to-date. They love more lending — needing it to fuel growth and earnings.
Global curve steepening alone won’t dictate markets’ direction. But that few see or celebrate it means its power isn’t spent. Its stealthiness provides it more power – and favours European and value stock leadership lasting.
Ken Fisher is the founder, executive chair and co-chief investment officer of Fisher Investments.