One of the most widely followed indicators of potential recession risk on the US bond market has reached levels not seen since 2007.
The yield on the benchmark 10-year Treasury note fell as low as 12 basis points below the 2-year rate, surpassing the gap of 9.5 basis points reached in early April. The spread was narrowed to approximately 8.5 basis points in advance of the $33 billion 10-year note auction scheduled for 1 p.m. New York time, which will generate additional supply that may have a depressing effect.
Inversions of the yield curve, in which rates on longer-term maturities fall below those on shorter-term maturities, are viewed as a possible harbinger of a recession, given that a recession would weaken inflation and eventually lead to rate cuts. The spread between 2- and 10-year Treasuries is one of the most closely followed, and it is currently more inverted than it has been since 2007, prior to the 2008-2009 financial crisis.
According to Jan Nevruzi, a US rates strategist at NatWest Markets, “markets are focusing more on the possibility of an upcoming recession.” People do not wish to anticipate the trend, despite the fact that supply is forthcoming.
The current inversion is occurring at a time of rising concern that measures taken by central banks around the world to curb inflation may lead to a recession. This fear has contributed to a rebound in Treasury prices, which has reduced the benchmark 10-year rate from approximately 3.5 percent in mid-June to approximately 2.92 percent on Tuesday. Meanwhile, the two-year yield was around 3 percent, down from a session high of 3.05 percent.
Given that the Federal Reserve is intent on tightening monetary policy until inflation slows, the yield curve is likely to invert further, according to Gregory Faranello, head of US rates trading and strategy at AmeriVet Securities.
“We’ve been advocating for a deeper inversion,” he said, noting that Federal Reserve Chair Jerome Powell recently stated that the central bank is not concerned about an inverted yield curve. “An inversion of minus 25 to minus 50 basis points is not outside the realm of possibility and historical context,” I believe.
Other segments of the yield curve are also flattening, although some remain positive, such as the difference between the yields on 3-month bills and 10-year notes. This spread, which is utilized by the New York Fed and others in recession-prediction models, is approximately 74 basis points, down from a multi-year high of 234 basis points in May.
