U.S. Treasury yield curve turns positive

On the causes and consequences of the recent bout of market volatility, including why the Federal Reserve should avoid an emergency rate cut.
https://t.co/jpHiwNWAmO#economy #markets @opinion #econtwitter #FederalReserve

— Mohamed A. El-Erian (@elerianm) August 6, 2024

The U.S. Treasury yield curve, a key indicator of an impending recession, turned positive for the first time in two years on Monday. This development has raised concerns that the U.S. economy is heading into a downturn. An inversion in the yield curve comparing two- and ten-year Treasury yields typically signals that a recession is likely within the next one to two years. The current inversion has lasted longer than previous episodes.

Add to the fluid mix the stronger-than-expected US services data per the Bloomberg summary below. The US bond market is getting whipsawed.#economy #markets pic.twitter.com/U6zwtwREfv

— Mohamed A. El-Erian (@elerianm) August 5, 2024

The curve usually turns positive before a downturn begins, with short-term yields dropping faster than longer ones as the Federal Reserve is expected to cut interest rates to support a weakening economy. Matthew Nest, global head of active fixed income at State Street Global Advisors, stated, “An inversion is the long-leading indicator of recession, and a disinversion is the signal that maybe you’re entering or you’re near an actual recession.”

The S&P 500 is down 8.5% from its closing high on July 16, the largest drawdown of the year. The index is still up 9.6% year-to-date including dividends. Suffering through drawdowns is the price of admission for long-term investors, without which there would be no reward. $SPX pic.twitter.com/sCot3IdIia

— Charlie Bilello (@charliebilello) August 5, 2024

In the past four recessions, the 2/10 curve had turned positive by the time a recession occurred, according to a Deutsche Bank analysis.

Here's a look at the first Fed rate cut in prior cycles and forward S&P 500 returns. As we saw in 2001 and 2007 with the Fed cutting rates because of an oncoming recession, rate cuts are not necessarily the bullish signal that many claim them to be. pic.twitter.com/jhL9uNmQb5

— Charlie Bilello (@charliebilello) August 5, 2024

The interval between a disinversion and the beginning of a recession varied, ranging roughly between two and six months in those instances.

U.S. economy faces disinversion concerns

The 2/10 curve had been continuously inverted since early July 2022, surpassing a previous inversion record from 1978. Some market participants questioned its accuracy as a recession indicator this time due to optimism that the U.S. could avoid prolonged economic pain. However, weak economic data last week reignited recession fears and prompted a sharp repricing in U.S. interest rate cut expectations. Two-year Treasury yields have dropped over 50 basis points over the past week to 3.84%, while benchmark ten-year yields have decreased by about 40 basis points over the same period, last trading at 3.76%. The gap between the two hit 0.4 basis points in early trade, turning positive for the first time since July 2022. Later Monday, the curve inverted again, with two-year yields above long-term ones by about eight basis points. John Hancock Investment Management’s co-chief investment strategist Matthew Miskin said the disinversion is a signal that the market is “screaming that the Fed needs to cut rates.” He added, “Whether or not that’s justified, we’ll just have to see how lasting this risk-off environment is.”