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- US three- and five-year Treasury yields have inverted, while the two-year and 10-year benchmark is flattening.
- The Treasury “yield curve” can be seen as a proxy for investor sentiment on the direction of the economy.
- Weakening global growth, trade-war fears, higher interest rates, and wariness over the extent of Federal Reserve tightening are weighing on markets.
A darkening tone has taken over bond markets, and it could spell trouble for the US economy.
On Monday, two- and five-year Treasury yields inverted, meaning the shorter-dated two-year money became more expensive than the later-maturing five-year. The same happened with three- and five-year spreads for the first time in 11 years. Concerns about global growth slowing and higher interest rates, coupled with simmering trade-war tensions, are thought to be behind the inversions.
“Inversion of that curve is the real recession red flag,” said Neil Wilson, the chief market analyst at Markets.com.
Generally, short-term bonds carry lower yields because the investment is considered less risky, whereas longer-dated funds have higher yields to reflect the view that an investor’s money is at more risk as you commit for more time.
Investors are increasingly concerned, however, by a flattening of the spread between two- and 10-year Treasurys, a more fundamental benchmark of market health. The 10-year Treasury note yield fell about 6 basis points to 2.498% on Tuesday, its lowest since September 13, while the spread between two- and 10-year notes dropped to 0.14%, the flattest level since June 2007, setting the tone for a possible inversion of spreads in the future.
From 1988 to 2008, inversions of the twos and tens were followed by recessions about 24 months later, according to Wells Fargo, cited by CNBC.
The yield curve inverted between the two- and 10-year yield before the recessions of 1981, 1991, 2000, and 2008. It has preceded all nine US recessions since 1955.
An inversion implies that investors are selling short-dated bonds faster than their long-dated counterparts, because bond prices fall as yields rise. It’s a sign investors are unmoved by a potential slowdown in the Federal Reserve’s interest-rate-hiking program. Investors are still expecting the Fed to raise rates by 0.25% in December, despite interpretations that comments from Chairman Jerome Powell signal a more dovish stance.
Recessionary pressures could be exacerbated if fears surrounding the US-China trade war are resumed following a 90-day truce, agreed to at the G20 summit in Argentina last week.
“This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that,” Ian Lyngen, the head of united rates strategy at BMO Capital Markets, told CNBC.
Lyngen said the inversion of three- and five-year yields had increased the likelihood that an inversion of the two- and 10-year yield would happen by early 2019.
Whether that means a recession is likely in the next few years depends on numerous factors, but it’s a stark sign of things to come from a usually emphatic bellwether.