I’ve been mesmerized over the past few days by this amazing graphical representation of the bond-yield curve in the New York Times. But before we get to it, what does the bond-yield curve inversion mean, and why should it be important to you as an aspiring or current in-house lawyer?
First of all, “inversion” in this context refers to a situation in the bond markets where short-term bond yields are higher than long-term yields (for bonds of similar credit, like U.S. Treasuries). But what is a bond yield, and how is that different from an interest rate?
First, bonds are issued at a “par value” paying whatever the prevailing interest rate might be, and over some period of time (1-year, 2-year, 10-year, 30-year, etc.). Typically the longer a bond must be held before it reaches maturity, the higher the interest rate it must offer in order to accommodate the economic and market uncertainty of tying up investors’ principal for increasingly extended durations.
But the price at which those bonds will trade in the market after they’ve been issued will vary depending on market forces. For example, suppose you buy a $1000 bond, which is paying a 10 percent interest rate. The yield of this bond is then 10% ($100 in interest divided by the $1000 “par” value.)
Then, suppose bond prices rise. This typically happens when something spooks equity (i.e. stock) investors – like Trump’s trade war, or weak employment data, or any other reason that sends investors scurrying to the relative safety of bonds and boosting demand for them.
So let’s say our $1000 par-value bond spikes in price to $1200. All of a sudden, that same bond is yielding only 8.33% (the same $100 in interest that it pays on the $1000 par value divided by $1200, or the current price the bond is fetching in the market).
It’s also important to remember that bond yields will generally move in the same direction as interest rates (but bond prices will move inverse to interest rates, which is confusing). For example, if interest rates rise, investors will try and sell the existing bonds they’re holding that are paying the current, lower interest rates and purchase new bonds paying a higher rate. So bond yields in the market will also rise as the price of their underlying bonds fall. (The opposite is also true.)
What’s happening now, though, is that yields on long-term bonds are drifting lower than those on short-term bonds. In other words, investors are betting that, in the future, interest rates will stay depressed on account of a sluggish economy. This means that investors are less bullish on the future than they are on the present – and in the past, this has been a pretty good leading indicator of a recession.
For that reason, they are purchasing longer-term bonds in order to lock in interest payments at a higher rate, driving up bond prices, and therefore depressing their yields. On the other hand, because they are less inclined to purchase shorter-term bonds knowing that at maturity the proceeds from those bonds must be reinvested in a lower interest-rate environment, investors are driving down the prices of those bonds, and spiking their yields.
So what – if anything – does this situation mean for in-house lawyers, or firm lawyers who are thinking about making the move in-house in the near future?
First, if you’re on the fence about making a move in-house, or have only just started considering it, the inverted yield curve might be a sign that it’s time to take the plunge sooner rather than later. Hiring obviously ticks down in a recession, and overhead like expensive in-house lawyers could be the first open requisitions to get canceled.
Second, if you’re already in-house, you should be positioning yourself internally for a “recession-proof” position. While I’ve argued before how I believe that Corporate is the best place to work as in-house lawyer, in a downturn it’s overhead that’s the first to go. If you’re supporting Operations, on the other hand, somebody needs to help keep the lights on. Your position there, then, might be safer.
Third, if you’re still in a law firm and not ready to make the jump, keep working hard to make yourself indispensable. If there is a recession, and billable hours become harder to come by, don’t be the low-hanging fruit that management is quick to cut. It’s possible to survive a recession or market turmoil within a law firm. But you need to be viewed as something more than a cog in the machine.
Finally, I think it underscores that all of us need to be saving as much as possible. While it’s not a guarantee of a recession on the horizon, the odds are good that the data is portending one, and we should all be prepared in the event that job cuts happen. (Our Ultimate Family Finances Spreadsheet is a great tool to help make that happen!)
Of course, nobody – not even the bond markets! – can predict the future. But the bond-yield curve over time has been a good leading indicator. So my advice is to consider the inversion carefully in light of your own professional situations.
Are you thinking about the inversion at all? Are you making any changes in your career planning because of it?
Let us know in the comments!