A Key Bond Market Recession Indicator Is Now Flashing Red

A key indicator of fear about an economic downturn flashed red on Monday for the first time since 2006, fueling fears of a recession...

On Monday morning, the yield on the five-year Treasury note increased to 2.64% — higher than the yield on 30-year notes, which dropped to 2.60%. The “inversion,” as it’s known to investors, was short-lived, but the curve on the two notes remained flattened as of Monday afternoon, with the five-year yield sitting at 2.55% and the 30-year at 2.57%.

Yield curve inversions can portend recessions as they show investors have little faith in the ability for growth to pick up in the coming years. The signals from bond markets are still relatively faint, as the more closely watched spread between the two-year yield and the 10-year has remained positive throughout Monday. Still, economists warned the market is signaling recession risk.

“Markets are fixated on the U.S. Treasury yield curve, as it is considered an excellent gauge of the economy,” said Anu Gaggar, global investment strategist for Commonwealth Financial Network. “If the economy is healthy and growing, longer-term Treasury rates should be higher than shorter-term rates. When the reverse happens, concerns start to mount about the future state of the economy.”

The flattening yield curves come after the Federal Reserve announced it would raise its interest rate target by a quarter of a percentage point, the first rate hike since 2018. Fed Chairman Jerome Powell has also signaled the central bank might be more aggressive in hiking rates at its forthcoming meetings in response to the country’s breakneck inflation.

“With the Fed set to hike into restrictive territory, the curve will invert,” said Seth Carpenter, chief global economist at Morgan Stanley, according to CNBC. “As has always been the case in the past, markets will debate whether an inversion presages a recession. A policy mistake that causes a recession is clearly possible, but our baseline is that an inversion without a recession is more likely.”

Most investors now foresee a half-point hike in May, with the likelihood of the more aggressive rate hike occurring pegged at more than 74%, according to CME Group’s FedWatch tool, which calculates the probability using Fed fund futures contract prices.

Monday’s yield curve inversion raises the fear that Fed is jacking up interest rates too quickly as it tries to curb inflation. Consumer prices rose 7.9% for the 12 months ending in February — the fastest pace since 1982.

The prospect of either sticky inflation or a noticeable economic downturn caused by rapid rate hikes is not a favorable prospect for President Joe Biden, who is trying to ensure Democrats retain control of Congress and is facing the headwinds of poor approval ratings. Some economists have warned about the trouble with inflation and interest rates for months.

Bill Dudley, the former president of the Federal Reserve Bank of New York, warned last June in an op-ed about the risk of recession from the central bank’s policies. He pointed out the Fed wanted to keep rates at near-zero until there was maximum employment, inflation had reached 2%, and higher prices were expected to remain above that level for some time — all things the Fed now says have happened.

“This means monetary policy will remain loose until overheating begins — and cooling things off will require the Fed to increase interest rates much faster and further than it would if it started raising rates sooner,” Dudley said of the prospects for a “hard landing.”

The stock market has been all over the place the past few weeks given the uncertainty surrounding the Fed’s rate hikes and about the Russian war in Ukraine, which does not appear to be abating and is cutting into Europe’s 2022 growth prospects and sending energy prices through the roof.

The last recession, the shortest in U.S. history, lasted about two months at the outset of the COVID-19 pandemic in 2020.

Goldman Sachs researchers see the odds that the United States enters a recession during the next year as sitting at about 20% to 35%. The financial services giant cut its forecast gross domestic product growth for the U.S. to 1.75% this year after previously forecasting a 2% increase in GDP. ✪

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