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Analysis – US Treasury yield curve lights red for investors

People walk past the New York Stock Exchange (NYSE) in Manhattan, New York City
People walk past the New York Stock Exchange (NYSE) in Manhattan, New York City, the United States, August 9, 2021. REUTERS/Andrew Kelly

March 29, 2022

By Megan Davies and Ira Iosebashvili

NEW YORK (Reuters) – The U.S. Treasury yield curve is a warning sign for Wall Street, where many fear a recession may be looming after bond investors have pushed short-term interest rates to the point where yields for the 2-year Treasury bonds were actually higher than the 10-year Treasury bonds.

One such phenomenon, dubbed “yield curve inversion,” is a key metric investors watch as bond yields impact other asset prices, affect bank yields, and are an indicator of how the economy will perform . Aside from potentially signaling the economy, the shape of the yield curve has implications for consumers and businesses.

On Tuesday, one of the most closely watched parts of the curve, the 2-year to 10-year curve, briefly inverted after weeks of sharp moves in the US Treasury market, where investors sold Treasuries as they traded aggressively The US Federal Reserve, which is fighting rising inflation, expects interest rate hikes.

US Treasury yield curve inverted

That was a warning sign for investors that a recession could follow. The last time it reversed was in 2019 and the following year the United States slipped into a recession – albeit one caused by the global pandemic.

“A lot of people focus on that and there might be a self-fulfilling expectation, they see the 10-year/2-year inversion and they think there’s going to be a recession and there’s going to be a change in behavior,” said Campbell Harvey, professor of economics Finance at Fuqua School of Business, Duke University, who pioneered the use of the yield curve as a recession forecasting tool. “So if you’re a business, cut back on investment and employment plans.”

Harvey, who focused his research on a different part of the yield curve, added that it’s “not a bad thing” to be prepared for a recession…so if it happens, you’ll survive.

Broker-dealer LPL Financial said the 2/10 inversion was “a strong indicator,” noting that it preceded all six recessions since 1978, with just one false positive.

According to Anu Gaggar, global investment strategist at Commonwealth Financial Network, the lag between curve inversion and the onset of a recession averaged about 22 months, but has ranged from 6 to 36 months in the last six recessions.

2/10 curve

Some investors warn that the yield curve is just one indicator among many to look for when forecasting a recession. In fact, stock markets have rallied in recent weeks, with the S&P 500 trimming its year-to-date loss to about 3% after confirming it was in a correction over the past month.

For many market participants, however, the curve has become a classic signal to follow.

“There’s definitely a psychological element,” said Gennadiy Goldberg, senior rate strategist at TD Securities. “The yield curve has worked in the past because it was a signal that the end of the cycle was coming.”

CLOSELY FOLLOWED

Short-term US Treasury yields have risen rapidly, reflecting expectations of a series of rate hikes by the US Federal Reserve, while longer-dated Treasury yields have moved more slowly amid concerns that monetary tightening could hurt the economy.

As a result, the shape of the US Treasury yield curve has generally flattened and in some cases inverted.

Not everyone is convinced that the curve tells the whole story. Some say the Fed’s asset-buying program over the past two years has inflated the price of 10-year Treasuries and kept yields artificially low. They say yields will rise as the central bank starts shrinking its balance sheet and steepening the curve.

The picture is clouded further as different parts of the yield curve have sent different signals.

While financial markets view the two-year yield as a good predictor of Fed policy and follow the 2/10th part of the curve closely, many academic papers favor the spread between the yield of three-month Treasury bills and 10-year notes. This yield curve does not indicate a recession.

Eric Winograd, Senior Economist, AllianceBernstein, said the yield curve inversion discussion was “overheated”.

“I get the narrative and think that from a risk-on perspective there is good evidence that a flat or inverted yield curve poses a challenge for broader risk assets, but I will stop worrying about a recession when the yield curve inverts 5 basis points or not,” said Winograd.

Investors may be wary of an inversion this time around as the Fed stays early in the rate hike cycle and has time to ease the brakes if the economy appears to be slipping into a downturn, TD’s Goldberg said.

Fed researchers, meanwhile, published a paper on March 25 that suggested the predictive power of the spread between two- and 10-year Treasury bonds as a signal of an impending recession is “probably wrong” and a better harbinger of a coming economic slowdown is the spread of Treasuries Maturities of less than two years.

Still, for some, the trend is unmistakable.

“When things turn around, you’re definitely a lot closer to a recession than a good outcome, and that’s where we are today,” said Edward Al Hussainy, senior interest rate and currency analyst at Columbia Threadneedle. “It is clear that we have arrived at a point of tension in the markets.”

(Reporting by Megan Davies, Ira Iosebashvili, additional reporting by Lewis Krauskopf, Dan Burns and David Randall; writing by Megan Davies; editing by David Gregorio and Andrea Ricci)

https://www.oann.com/analysis-u-s-treasuries-yield-curve-flashes-red-to-investors/?utm_source=rss&utm_medium=rss&utm_campaign=analysis-u-s-treasuries-yield-curve-flashes-red-to-investors Analysis – US Treasury yield curve lights red for investors

DUSTIN JONES

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