Deeply inverted Treasury curve narrowly misses 41-year milestone

The bond market indicator of an impending recession in the US nearly hit its lowest reading since October 1981, when interest rates were 19% under Paul Volcker’s Federal Reserve.

This sensor, which measures the spread between 2- TMUBMUSD02Y,
4.492%
yield of 10-year treasury bonds TMUBMUSD10Y,
3.668%,
ended the New York session on Thursday at minus 82.5 basis points. In other words, the 10-year yield traded 82.5 basis points below the 2-year yield.

For most of the day, the spread appeared to be approaching a December 7 low of minus 84.9 basis points and approaching its most negative level since October 2, 1981, when it hit minus 96.8 basis points. Dow Jones market data. Instead, it fell just below the December mark.

Source: Tradeweb ICE

The ongoing inversion comes as investors and policy makers prepare for more Federal Reserve rate hikes and a period of disinflation or slower inflation that may take some time to overcome. One of the possible upsides behind Thursday’s bond market action is that many investors seem to believe that the Federal Reserve will stick to its inflation campaign and eventually win it.

Shares initially rose on Thursday but lost gains around noon. All three major stock indices ended the day lower, including the Dow Jones Industrial Average DJIA,
-0.73%
by 0.7%, S&P 500 SPX,
-0.88%
down 0.9% and the Nasdaq Composite down 1%.

Stock market today: Dow cuts profits as erratic trading pattern continues

“Our call for 2s/10s to reach -100 basis points is back in place after appearing less realistic” late last year, with the spread closing near minus 55 basis points, BMO Capital Markets strategists Jan Lingen and Ben Jeffery said in a note in Thursday.

For most of Thursday, the 2s/10 spread seemed poised to turn more negative than at any time since October 1981, when headline annual CPI inflation was above 10% and the federal funds rate was around 19%. under Volcker, and the US economy was experiencing one of the worst recessions since the Great Depression.

But after a weak 30-year auction in the US this afternoon, the 10-year bond rate rebounded, along with almost every other yield on the curve, as investors sold off Treasuries.

The negative 2s/10 spread simply means that the 2-year Treasury rate is trading well above its 10-year counterpart as bond investors and traders factor in a short-term Fed rate hike along with lower inflation and/or poor economic outlook. long-term perspective.

Typically, Treasury bond spreads should slope upwards when the outlook is favorable; it slopes down and becomes negative when there is more pessimism. The more negative the spread, the more negative the bond market message is thought to be, though strategists at Goldman Sachs and yield curve pioneer Campbell Harvey caution against tying inversions to recessions.

Read: Deeply inverted Treasury yield curve does not signal looming recession: Goldman Sachs

See also: An economist who pioneered the closely watched recession tool says it could be sending a “false signal.”

Traders, strategists and investors switch between two versions of the most likely inflation path. One is that the US could enter a period of “temporary disinflation” in which any rise in prices in a cooling environment would be fleeting. Second, there could be a rapid and unexpected fall in inflation, with the overall annual CPI reaching 2% within a few months, on the assumption that the US economy cannot escape it. recession.

See: Economist at Top Wall St. says no-landing scenario could trigger another tech-driven stock market sell-off

Villanova University business professor Peter Zaleski believes the two narratives are essentially the same, with the only difference being that one estimates the strength of the US economy as a key factor in determining how quickly inflation can fall.

Among other movements in the bond market on Thursday, the second indicator of a recession is the spread between the rates of 3-month GKO TMUBMUSD03M,
4.757%
and the 10-year Treasury yield fell to minus 105.7 basis points from a record low of minus 127.73 basis points on January 18.

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