Evercore Warns of Rising Yield-Curve Inversion Risk Amid AI Rally

Evercore ISI is flagging an increasing risk of a U.S. yield-curve inversion, a classic recession indicator, as Federal Reserve policy and rising long-term bond yields squeeze the spread between short- and long-dated government debt. The warning comes even as the powerful, artificial intelligence-driven rally in equities remains largely intact, according to a note from the firm's strategists.

The Flattening Curve

Strategists at Evercore ISI noted that the spread between 2-year and 10-year Treasury yields has "flattened materially," drawing a parallel to a similar move that preceded the yield-curve inversion in 2022. An inverted yield curve, where short-term borrowing costs exceed long-term ones, is historically considered a leading indicator for economic recessions and stock market downturns.

While an inversion often precedes a recession, Evercore points out that the timing can vary significantly. The average lead time between an inversion and a subsequent recession has been about 15 months, though the firm also highlighted that the inversions of 1998 and 2022 were not followed by economic contractions.

Market Impact and Strategy

For equity investors, an inversion has historically led to near-term volatility and sideways trading but does not necessarily signal the end of a bull market. Evercore referenced 1998, when a brief inversion was followed by a 22% market drawdown but did not derail the broader structural bull market.

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Despite the rising bond market risks, Evercore is not advising clients to abandon the current market leaders. The firm is retaining its long exposure to AI-related sectors like Information Technology, Communication Services, and Consumer Discretionary, arguing there is not yet clear evidence of economic damage from current headwinds.

Instead of a full-scale retreat, strategists recommend a "partial defensive tilt." Historically, Technology stocks have tended to outperform leading up to an inversion, while more defensive sectors such as Health Care and Consumer Staples have shown relative strength in the period after an inversion as market volatility increases.

Conflicting Economic Signals

The firm's cautious-but-not-bearish stance is supported by a mixed economic picture. Positive indicators include expansionary corporate surveys and subdued jobless claims.

However, significant pressure points remain. Evercore cited oil prices near $95 a barrel and 10-year Treasury yields trading above 5% as key risks for investors to monitor.