Potential recession signal: A key 'yield curve' has inverted

Daniel Fowler
March 24, 2019

USA markets received a clear warning of coming recession on Friday when the spread between yields on three-month Treasury bills and 10-year notes fell below zero for the first time since 2007 after US manufacturing data missed estimates.

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This particular indicator lies within the bond market, where investors show how confident they are about the economy by how much interest they're demanding from US government bonds.

The U.S. curve has inverted before each recession in the past 50 years. The yield on the benchmark 10-year Treasury note, which is used to set rates on mortgages and many other kinds of loans, fell to 2.45 percent from 2.54 percent late Thursday, a big move. Moves in the yield curve are clearly leading equities.

"Yield curves are responding to what they see, to what I believe is a global economic slowdown", said Peter Boockvar, chief investment officer at Bleakley Advisory Group, told CNBC. "While an inversion has [preceded] each recession over the past 50 years, the lead time is extremely inconsistent, with a recession following anywhere from 14-34 months after the curve goes upside down".

The pan-European STOXX 600 index lost 1.22 per cent and MSCI's gauge of stocks across the globe shed 1.48 per cent. High demand for bonds will, in turn, send yields falling.

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Just to illustrate how captivating the yield curve has been to the equity market, check out an intraday chart of S&P 500 futures versus the yield curve since very early this morning. In that situation, a 10-year note, for instance, may offer only a modestly higher yield than a 3-year note.

As Barron's reports, short-term bond yields reflect current economic strength, while "the long-term end of the yield curve - 10-year Treasuries and further out - is thought to indicate bond investors' long-term views of the market". The front-end to intermediate part of the curve inverted for the first time in a decade back in December.

While the 3-month to 10-year spread "has a relatively decent track record of predicting recessions, it suffers from a timing problem", said TD Securities U.S. rates strategist Gennadiy Goldberg.

The US Federal Reserve signaled on Wednesday that it would not raise interest rates this year, pointing out that the pace of economic activity has slowed. Inversion is considered a reliable harbinger of recession in the US, within roughly the next 18 months. Stephen Bartolini, a fixed-income manager at T. Rowe Price, says the real surprise was just how little growth the Fed sees next year.

Policymakers, in the Fed's statement, also forecast just one rate hike through 2021.

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