Yield curve inverts for first time in a decade

Gold Bangles

Gold Bangles

One of the most reliable warning signals for a recession just got a bit brighter.

U.S. 3- and 5-year Treasury yields have inverted, while the 2-year and 10-year benchmark is flattening. During an economic downturn, which is one reason why the yield curve inversion is spooking the market.

The spread between the two-year and 10-year Treasury yields was at its flattest level in more than a decade and edging closer to an inversion, when long rates fall below short rates. Conversely, the longer the money is invested, the higher the interest rate to offset the additional risks, especially inflation.

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Despite the usual signal coming from two-year and 10-year Treasury yields, Canning said the inversion on Tuesday has investors anxious.

The yield curve inversion and comments from Fed speakers are causing investors to rethink the potential of a recession or if rate hikes are nearing the top, said Minh Trang, senior FX trader at Silicon Valley Bank in Santa Clara, California. On Monday of this week, the USA government's five-year bond yielded less interest than the three-year bond. Shanghai markets fell 0.6 per cent, their losses limited by Chinese officials expressing confidence that a trade deal would be clinched on time.

The usually unremarkable "yield curve" made investors sit up and take notice this week as it signaled a possible recession on the horizon, sending stocks plummeting.

No, at least not yet. That signalled to some investors an approaching US economic slowdown. But most economists say the chances of a near-term recession are slim, pointing to strong hiring and consumer spending, among other positive trends. Benchmark 10-year notes gained 13/32 in price to yield 2.966 percent the lowest since September 13. The euro was 0.11 percent lower.

Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab. It was 0.6 percent off a 17-month peak of 97.693 touched on November 12. The Federal Reserve is widely expected to raise rates at its meeting on December 18-19. An inversion in that part of the curve has preceded each of the last seven recessions.

A precarious situation for the Fed undoubtedly and one that I believe they will be forced to respond to with either an outright suspension of rate hikes for the next six months - potentially skipping the expected rate hike this meeting as well - or with a rate hike accompanied by very strongly worded assertions that the Fed will not raise rates again for an extended period of time and that rate hikes may themselves be in store in the very near future.

Even if the more important parts of the yield curve flip to inversion, that doesn't mean a recession will happen the next day.

That boosts the cost of borrowing for American households, and in turn pushes short-term Treasury bill rates higher, while putting downward pressure on long-term rates.

Actually, I expect a recession before that portion of the curve inverts.

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