The yield curve, which shows how interest rates on different U.S. government bonds such as 3-month bills, 2-year and 10-year Treasury notes compare, as well as functions as a recession indicator, is ringing alarm bells on Wall Street, portends an article in The New York Times. Normally the yield curve slopes upward, but occasionally, when short-term rates climb higher than long-term rates, the curve inverts, signaling that the bond market is turning upside down. That inversion is happening now.
As the Fed tackles persistent inflation by swiftly raising interest rates, yields on short-term Treasurys such as the 2-year note have gone up; last month, they stood at 2.97%, higher than the 2.75% yield on 10-year note. Last year, those 2-year yields were 1% lower than 10-year. And as investors get more and more worried that the Fed will slow the economy right into a recession, longer-term Treasurys like the 10-year are falling along with investor confidence, the article details.
The yield curve has a predictive power, and this is the strongest recession signal it’s sent since the dot-com bubble burst in late 2000. A recession hit just a few months later, and stretched on for 8 months. Likewise, the yield curve inverted in late 2005, portending the global financial crisis that would hit 2 years later. That history is why investors are paying attention to the yield curve now. “…ignore it at your own peril,” Greg Peters of PGIM Fixed Income told The Times.
While most analysts watch the relationship between 2-year and 10-year yields, others choose to zero in on the relationship between 3-month and 10-year notes because they believe that correlation captures Wall Street’s expectations of what the Fed will do in the short-term. Right now, 3-month yields are still lower than 10-year yields, meaning the curve hasn’t inverted by that measure, though the gap is quickly narrowing as recession fears escalate.
Still, there are plenty of analysts who think the focus on the yield curve is overblown. It doesn’t indicate the timing of a recession, and the market has changed mightily since the measure was last popular during the 2008 financial crisis. But used in conjunction with other tools, such as watching corporate spending and borrowing, it can be a helpful indicator. And all of those tools are pointing to the same thing right now: that risk is climbing upward, and the expectations for a recession are becoming more and more common.