The market’s most closely watched part of the yield curve inverted very briefly on Tuesday.
At 1:33 p.m. ET on Tuesday afternoon, Bloomberg data showed the yield on the 10-year U.S. Treasury note (^TNX) briefly dipping below the yield on the 2-year U.S. Treasury. The inversion lasted only a few seconds, and by 3:00 p.m. ET (the settlement time for U.S. government bond futures) the curve remained un-inverted with about 0.05% separating the two securities' yields.
Over the last half-century the yield curve inversion has been a recession indicator. But others say the Federal Reserve’s unprecedented firefight with high inflation would make a yield curve inversion different from those of decades’ past.
This phenomenon has a strong track record of predicting a recession; each of the last eight recessions (dating back to 1969) were preceded by the yield on the 10-year falling below the 2-year.
The “yield curve” maps out U.S. Treasuries of various durations, and usually shows longer-dated Treasuries (like those with 10-year or 30-year maturities) having higher yields than shorter-dated Treasuries (i.e. 3-month or 2-year maturities).
[Read: Bonds, yields, and why it matters when the yield curve inverts — Yahoo U]
The curve “inverts” when yields on shorter-dated Treasuries rise above those of longer-dated ones. Points of the curve have already inverted in recent weeks (the 3-year and the 5-year on March 18, the 5-year and the 30-year on March 28).
But the 2-year and 10-year points are often looked to because they are among the most commonly traded durations. An inversion in these particular points has correctly predicted a recession with a lead time of between eight months and two years in each of the last eight recessions.
Recession incoming?
However, there is nothing about bond pricing that directly triggers a recession. For example, the first recession warning ahead of the 2020 downturn arrived in the form of a yield curve inversion in August 2019. But financial markets could not have known a global pandemic would be the reason for that recession.
And despite the inversion’s strong track record for predicting recessions, some strategists have warned that more context is needed when looking at this year’s inversion among 2-year and 10-year yields.
In the face of rapid inflation, the Federal Reserve is in the process of hiking interest rates at its fastest pace since 1994. Bond markets have had to quickly reprice through this policy pivot, meaning that inversions could be a temporary side effect of the Fed’s actions (instead of a more fundamental market worry about duration risk).
“There are some real distortions in the yield curve right now,” JPMorgan Asset Management’s Meera Pandit told Yahoo Finance on March 21. She added that there are also two other narratives keeping longer-end yields down (thus flattening and inverting the curve): foreign interest in U.S. Treasuries and the Fed’s direct ownership of trillions in U.S. Treasuries.
BofA Global Research wrote March 25 that a yield curve inversion would be a “distraction” given a U.S. economy that had its fastest labor market recovery (now at a near-historic low unemployment rate of 3.8%) and GDP growth back to pre-pandemic levels.
“In our view, the bottom line is that near-term recession concerns are likely overdone,” wrote BofA Global Research on March 25.
Brian Cheung is a reporter covering the Fed, economics, and banking for Yahoo Finance. You can follow him on Twitter @bcheungz.
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