Bonds signal recession as yield curve reverses again

The Treasury yield curve warns of a possible recession.

One closely watched measure shows that the bond market is giving a warning that the economy may be falling or has already fallen into a recession.

Market experts keep an eye on the spread on the Treasury yield curve, which is the difference between the yields on longer-term and shorter-term Treasury bonds. Most of the time, longer-term yields, such as the yield on a 10-year note, are higher than shorter-term yields, such as the yield on a 2-year note. But the yield on a 2-year bond is now higher than the yield on a 10-year bond.

As of Tuesday at noon, the 2-year Treasury yield was 2.792 percent, which was higher than the 10-year rate of 2.789 percent. Here, you can see this key's spread in real time.

This so-called "inversion" is a sign that the economy might be getting worse and that a recession is possible.

Ian Lyngen, head of U.S. rates strategy at BMO, said, "There's something going on with investor sentiment that's hard to ignore, given that the inversion is happening when 10-year yields are below 3%." "I wouldn't say that it's a clear sign that a recession is coming up soon. Instead, it fits with the growing worry about a recession."

Think about what it means for a bank to get an idea of how important the yield curve is. The yield curve shows the difference between how much a bank pays for money and how much it can make by lending it out or putting it in investments for a longer time. If banks can't make money, they can't lend money and the economy slows down.

After jumping to almost 3.5 percent in the middle of June, the yield on a 10-year bond has dropped to 2.78 percent and was hovering just below the yield on a 2-year bond, which was at 2.79 percent. The 10-year went up because investors were worried about inflation, but it went back down when they started to worry more about the economy. Yields move the other way from bond prices.

Many people keep an eye on the benchmark 10-year because it affects the rates for mortgages and other loans. The Fed's interest rate hikes have a much bigger effect on the 2-year, and it has been going up.

Gregory Faranello, who is in charge of U.S. rates at AmeriVet Securities, said, "I don't know if it's a sign of a recession by itself." "The Fed is fighting a battle between inflation and growth. Still, I think inflation is more important than growth."

The 2-year to 10-year curve inverted for the first time on March 31, and then briefly again in June. Faranello also said that the curve had turned upside down in 2019, which was a sign of an upcoming recession. But because the Federal Reserve was cutting interest rates at the time, he said that if it weren't for the pandemic, there might not have been a recession in 2020.

Certainly, some investors and economists want to see the inversion last for a long time before they think it means a recession is coming.

In the past few weeks, the possibility of a recession has scared the market even more. The economy isn't doing as well as it was, and Federal Reserve Chairman Jerome Powell has said that the central bank will keep fighting inflation with the same level of force. Investors are worried that the Fed will raise interest rates so much that the economy will slow down so much that it will go into a recession.

Even though the market has become scary, most Wall Street economists don't think there will be a recession this year. However, some think the economy could shrink next year.

Faranello said that Powell was recently asked about the possibility of an inversion of the yield curve. "His reply was, 'Right now, we're not worried about that. We're worried about getting inflation down to 2%.' It's definitely inflation over growth, and the Fed isn't worried about an inverted yield curve, said Faranello.

Investors are paying attention to both weaker data and the Atlanta Fed's GDPNow indicator, which says that the gross domestic product fell by 2.1% in the second quarter. The forecast is based on the data that has come in. If the economy shrinks again in the second quarter, it would be the second negative quarter in a row. This is what is called a recession.

"The closer it gets to the actual print, the more likely it is to be true, because it builds up," Lyngen said. Growth slowed down by 1.6% in the first quarter.

When the yield curve inverts, according to Bespoke, "there has been a better than two-thirds chance of a recession in the next year and a greater than 98 percent chance of a recession in the next two years."