Bond market is flashing a warning sign that a recession may be coming
David Dee Delgado | Getty Images News | Getty Images
The bond market is flashing a warning sign for the U.S. economy.
That harbinger is called an “inverted yield curve.” These inversions in the bond market have been reliable predictors of past recessions. Part of the yield curve inverted on Monday.
An economic downturn isn’t assured, though. Some economists think the warning is a false alarm.
Here’s what to know.
What’s an inverted yield curve?
Why is it a warning sign?
An inversion in the yield curve doesn’t trigger a recession. Instead, it suggests bond investors are worried about the economy’s long-term prospects, Roth said.
Investors pay most attention to the spread between the 2-year U.S. Treasury and the 10-year U.S. Treasury. That curve isn’t yet flashing a warning sign.
However, the 5-year and 30-year U.S. Treasury yields inverted on Monday, the first time since 2006, before the Great Recession.
“It doesn’t mean a recession is coming,” Roth said of the inversions. “It just reflects concerns about the future economy.”
The 2- and 10-year Treasury yield curves inverted before the last seven recessions since 1970, according to Roth.
However, data suggest a recession is unlikely to be imminent if one materializes. It took 17 months after the bond-market inversion for a downturn to start, on average. (Roth’s analysis treats the double-dip recession in the 1980s as one downturn.)
There was one false alarm, in 1998, she said. There was also an inversion right before the Covid-19 pandemic but Roth said it can arguably also be considered a false alarm, since bond investors couldn’t have predicted that health crisis.
“It doesn’t work all of the time, but it has a high success rate for portending a future recession,” said Brian Luke, head of fixed income for the Americas at S&P Dow Jones Indices.
Interest rates and bonds
The Federal Reserve, the U.S. central bank, has a large bearing on bond yields.
Fed policy (namely, its benchmark interest rate) generally has a bigger direct impact on short-term bond yields relative to those of longer-term bonds, Luke said.
Long-term bonds don’t necessarily move in tandem with the Fed benchmark (called the federal funds rate). Instead, investors’ expectations of future Fed policy have more bearing on long-term bonds, Luke said.
The U.S. central bank raised its benchmark rate in March to cool down the economy and rein in inflation, which is at a 40-year high. It’s expected to do so many more times this year.
There’s nothing magical about a yield-curve inversion. It’s not a light switch that’s flipped.
Preston Caldwell
head of U.S. economics at Morningstar
That has helped push up yields on short-term bonds. Yields on long-term bonds have risen, too, but not by as big a margin.
The yield on the 10-year Treasury was about 0.13% higher than that of 2-year bonds as of Monday. The spread was much larger (0.8%) at the beginning of 2022.
Investors seem concerned about a so-called “hard landing,” according to market experts. This would happen if the Fed raises interest rates too aggressively to tame inflation and accidentally triggers a recession.
During downturns, the Fed cuts its benchmark interest rate to spur economic growth. (Cutting…
Read More: Bond market is flashing a warning sign that a recession may be coming