For a brief moment, the U.S. bond market’s inverted yield curve was the largest it’s been since the early 1980s. That was around the time that then-Fed Chairman John Volcker took a toll on the economy in his fight against inflation.
The widely watched 2-year and 10-year U.S. Treasury yield spread has dipped from about 5 basis points (bp = 0.01%) since early July to minus 58 basis points on the 10th of this month. That contrasts with the 11% gain in the S&P 500 over the same period. Moreover, academics, analysts and investors see little chance of a reversal of the recent trend in which short-term yields outperformed longer-term bonds any time soon. An inverted yield curve is seen as a signal of recession.
Gennady Goldberg, senior rates U.S. strategist at TD Securities, expects the spread between 2-year and 10-year yields to widen to as much as 80 basis points. “An inverted yield curve shows that the current monetary policy trajectory will eventually drive the U.S. into recession,” he said. “The longer the yield curve continues to be inverted, the more investors and consumers will be wary of a recession, which could lead to self-fulfilling outcomes.”
2-10 Year Bond Yield Spread
Source: Bloomberg
Warning signals from the yield curve are not limited to 2-year and 10-year bonds. Yield spreads between 3-month and 10-year government bonds have also shrunk from a maximum of 234 basis points in May to about 19 basis points as of Wednesday. The 10-year bond yield even fell below the 3-month bond yield on the 2nd of this month.
The yield spread between 3-month and 10-year bonds is the focus of Campbell Harvey, a professor at Duke University’s Fuqua School of Business, who is known for deciphering the relationship between the shape of the yield curve and economic growth in his 1986 paper. . “Just because it’s flat underfoot isn’t good news,” he said. “Given what the market is doing and the rate hike is priced in, it looks like the 3-month and 10-year bonds will eventually reverse completely, and that would be an emergency,” he said.
The stock bulls who have funneled money into meme stocks, underperforming tech companies and even special purpose acquisition companies (SPACs) could be in for disaster. Strategists at Citigroup put the odds of a recession in the next 12 months at more than 50%.
It’s still unclear how long the recession will last or how deep it will be, but the yield curve and corporate bond spreads suggest it won’t be as bad as it was in the 1980s.
“It’s going to be somewhere between a soft landing and slowing inflation scenario and a severe recession,” Brian Nick, chief investment strategist at Nuveen, told Bloomberg Television. “The idea that the Fed will turn around and cut rates by March next year may be too much hope at this point,” he said.
news-rsf-original-reference paywall">Original title:
news-rsf-original-reference paywall">Bond Traders Dismiss Stock-Market Rally as Misguided Euphoria(excerpt)
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