This recession indicator is flashing a warning sign
The bond market is issuing a warning signal that has correctly predicted nearly every recession in the past 60 years: a potential inversion of the US Treasury yield curve.
An inverted yield curve is often seen as a signal that investors are more worried about the immediate future than the long term, causing interest rates on short-term bonds to rise relative to those paid on long-term bonds.
Although the curve has not yet reversed, it is getting closer. This shouldn’t be particularly surprising, given that Russia’s invasion of Ukraine – and its economic ramifications – continues to weigh heavily on the global economy.
Treasury bills are essentially a loan to the US government and are generally considered a safe bet for investors because there is little risk that the loan will not be repaid.
These government bonds have attracted a flurry of interest in recent weeks amid geopolitical uncertainty and tightening of financial conditions – The Federal Reserve said last week it was considering up to six more rate hikes in 2022 alone. That’s causing investors to lose their appetite for stocks and other more volatile assets and turn to reliable investments like treasury bills.
But, as more people rush to buy bonds, that drives the yield down, which ultimately makes it a less attractive investment. Some investors are even starting to seek out assets like Bitcoin and cash, which traditionally offer less stability than bonds.
A 10-year treasury bill generally offers a higher rate of return than shorter-term notes because an investor’s money is committed longer. Shorter duration treasury bills, such as 2 or 3 year bonds, generally offer lower yields because the risks are more predictable than longer duration. temporary horizon.
But when the yield on a 10-year note is lower than that on a 2-year note, it indicates a pessimistic outlook on the part of investors and a reluctance to commit their money. And yields are heading in that direction: the spread between the 10-year Treasury note and the 2-year note currently stands at around 0.2%, compared to around 1.5% a year ago.
An inversion of the yield curve has preceded every recession since 1955, according to a study by the Federal Reserve Bank of San Francisco.
A reversal does not mean that stocks are about to crash: while a reversal usually indicates that a recession is approaching in the following 12 months, it can sometimes take years. The curve inverted in 2005, but the Great Recession didn’t start until 2007. The last inversion, in 2019, raised fears of a recession – which materialized in 2020, but was due to Covid- 19.
Be that as it may, some market players are sounding the alarm.
“I think there could very well be a recession or even worse,” activist investor Carl Icahn said in an interview with CNBC on Tuesday. “We have a strong hedge against long positions…short term, I don’t even plan.”
There’s “at least” a one in three chance that the U.S. economy will experience a recession within the next 12 months, Moody’s Analytics chief economist Mark Zandi told CNN on Thursday.
“The harder the Fed brakes, the higher the likelihood of the car crashing and the economy going into recession,” Zandi said.