Yield Curve Inverts Again, To More Extreme Levels

Yield Curve Inverts Again, To More Extreme Levels
Luke Suddards

over 1 year ago1 min

The closely watched yield curve inverted in dramatic fashion last week, with the 2-year bond yielding as much as 0.586 percentage points more than the 10-year, a level not seen since the early 1980s (also a time when inflation was spiraling out of control). It’s not the first inversion we’ve seen this year, but it’s by far the biggest.

And this kind of move is always a worrying sign for investors: the curve (which takes the yield on US 10-year Treasury bonds and subtracts the US 2-year yield) is considered a gauge of the health of the US economy, after all. And when it inverts, that’s a signal that something’s amiss. What’s more, a yield curve “inversion”, as it’s known, has preceded each of the past 10 US recessions by 12 to 18 months.

So why is this happening now? Well, the 2-year government bond is considered a proxy for the Federal Reserve’s (the Fed’s) benchmark interest rate, which has been rising aggressively this year – around 4 percentage points – to levels last seen in 2007. Just last week, the Fed announced its fourth-straight 0.75 percentage point rate hike and signaled that more hikes were in the pipeline. And that’s increased fears that this aggressive string of hikes will push the economy into a recession. Meanwhile, the 10-year bond has a habit of fluctuating based on economic growth, inflation, and a liquidity premium (basically: investors expect higher compensation for holding the bond for longer).

If inflation data out on Thursday is red hot again, the inversion could become even more extreme, as investors price more rate hikes and stronger headwinds for the economy.

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