Treasury bond yield inversion raises worries over recession

Jun 13, 2022, 10:13 AM | Updated: Jun 14, 2022, 3:06 pm

FILE - Federal Reserve Board Chair Jerome Powell participates in a swearing-in ceremony, Monday, Ma...

FILE - Federal Reserve Board Chair Jerome Powell participates in a swearing-in ceremony, Monday, May 23, 2022, in Washington. On Tuesday,, June 14, 2022, Treasurys, the IOUs the U.S. government gives to investors who lend it money, provided an indication that a recession may be more likely as two-year Treasurys traded at 3.39% while 10-year bonds were yielding 3.36%. (AP Photo/Patrick Semansky, File)

(AP Photo/Patrick Semansky, File)

NEW YORK (AP) — One of the more reliable warning signals for an economic recession started blinking again.

The “yield curve” is watched for clues on how the bond market feels about the long-term outlook for the U.S. economy. On Tuesday, a closely followed part of the yield curve briefly lit up for the second time this year.

WHAT IS THE YIELD CURVE?

At the center of the investing world are Treasurys, the IOUs the U.S. government gives to investors who lend it money. The yield curve is a chart showing how much in interest different Treasurys are paying.

On one end are shorter-term Treasurys, which get repaid in a few months or a couple years. On the other end of the chart are longer-term Treasurys, which take 10 years or decades to mature. Short-term yields closely follow expectations for what the Federal Reserve will do with overnight interest rates, while long-term yields move more on expectations for economic growth and inflation further in the future.

Usually, longer-term Treasurys offer higher yields than shorter-term ones, resulting in a chart with an upward sloping line. That’s in part because investors typically demand higher yields to lock away their money for longer, given the possibility of future rate increases by the Fed and the risk of inflation. But when investors are worried about a sharp downturn, perhaps because the Fed is pushing short-term rates too high too quickly, they’re willing to accept less for a Treasury maturing many years in the future.

When yields for short-term Treasurys are higher than yields for long-term ones, market watchers call it an “inverted yield curve.” And when that chart has a downward sloping line, Wall Street starts getting nervous.

WHY CARE?

All the talk about charts and yields is tough to digest. An inversion in the yield curve is considered to be a reliable predictor of a recession, though at times they have inverted without a recession following.

Some market observers, including officials at the Federal Reserve, view the relationship between 3-month and 10-year Treasurys to be more important. Every recession in the past 60 years has been preceded by an inversion of the yield curve between the three-month and 10-year Treasurys.

There’s usually some lag between the two. One rule of thumb says it takes about a year after the three-month Treasury yield tops the 10-year yield before the onset of recession, according to the Federal Reserve Bank of Cleveland.

WHAT’S HAPPENING NOW?

At 1.75%, the three-month yield is still well below the 10-year yield of 3.48%, so no inversion there.

But on Tuesday, the two-year Treasury yield briefly crossed above the 10-year yield, before pulling back underneath at 3.42%. The two yields inverted previously in early April. Other, less-followed parts of the yield curve are also already inverted. Though they’re less consistent in predicting recessions as the three-month yield versus the 10-year, they show the trend is swinging toward pessimism.

Following an inversion in 2019, the global economy plunged into recession in less than a year. At that time, though, the bond market did not see the pandemic coming. It was focused on global trade tensions and slowing growth.

Now, the two-year yield is surging as investors become convinced the Fed will act more aggressively. The central bank has already pulled its key overnight rate off its record low to try to beat down high inflation and is preparing to hike rates several more times by larger than usual amounts.

A report Friday that showed inflation is getting worse solidified expectations among many investors that the Fed will hike overnight rates by double, or perhaps triple, the usual amount at its next meeting.

The two-year yield has more than quadrupled in 2022 alone. The 10-year yield has also risen, but not as quickly.

SO THE YIELD CURVE JUST REFLECTS THE BOND MARKET’S THINKING?

It could also have real effects on the economy. Banks, for example, make money by borrowing money at short-term rates and lending it out at longer-term rates. When that gap is wide, they make more in profit.

An inverted yield curve complicates that, though. If it causes banks to cut off lending — and thus growth opportunities for companies — it could help tighten the brakes on the economy.

IS IT A PERFECT PREDICTOR?

No, an inverted yield curve has sent false positives before. The three-month and 10-year yields inverted in late 1966, for example, and a recession didn’t hit until the end of 1969.

Some market watchers have also suggested the yield curve is now less significant because herculean measures by the world’s central banks have distorted yields. Through the pandemic, the Federal Reserve bought trillions of dollars of bonds to keep longer-term yields low, after slashing overnight rates to nearly zero. It recently began start allowing some of those bonds to roll off its balance sheet, which should add upward pressure on longer-term yields.

SHOULD I PANIC?

Fed Chair Jerome Powell would say no. Earlier this year, he said he pays more attention to the first 18 months of the yield curve than what’s going on between the two-year and 10-year yields.

“That has 100% of the explanatory power of the yield curve,” he said, and it’s not inverted.

And even though the two-year and 10-year Treasury yields inverted twice this year, they may be just temporary blips rather than a lasting trend.

Many investors, though, are worried about a recession or the possibility of “stagflation,” which would be the painful combination of high unemployment and high inflation.

The bond market, of course, also seems to be more pessimistic. Just look at the yield curve.

Copyright © The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten or redistributed.

AP

biden crisis averted...

Zeke Miller and Chris Megerian

Biden celebrates a ‘crisis averted’ in Oval Office address on bipartisan debt ceiling deal

President Joe Biden celebrated a “crisis averted” in his first speech to the nation from the Oval Office Friday evening.

1 day ago

Margrethe Vestager, Executive Vice-President for A Europe Fit for the Digital Age and Competition, ...

Associated Press

US, Europe working on voluntary AI code of conduct as calls grow for regulation

The United States and Europe are drawing up a voluntary code of conduct for artificial intelligence as the developing technology triggers warnings

1 day ago

FILE - Idaho Attorney General candidate Rep. Raul Labrador speaks during the Idaho Republican Party...

Associated Press

Families sue to block Idaho law barring gender-affirming care for minors

The families of two transgender teenagers filed a lawsuit Thursday to block enforcement of Idaho's ban on gender-affirming medical care for minors.

2 days ago

Amazon agreed Wednesday to pay a $25 million civil penalty to settle Federal Trade Commission alleg...

Associated Press

Amazon fined $25M for violating child privacy with Alexa

Amazon agreed Wednesday to pay a $25 million civil penalty to settle Federal Trade Commission allegations it violated a child privacy law

2 days ago

FILE - Candles are lit on a memorial wall during an anniversary memorial service at the Holy Trinit...

Associated Press

Pain and terror felt by passengers before Boeing Max crashed can be considered, judge rules

Families of passengers who died in the crash of a Boeing 737 Max in Ethiopia can seek damages for the pain and terror suffered by victims in the minutes before the plane flew nose-down into the ground, a federal judge has ruled.

3 days ago

OpenAI's CEO Sam Altman, the founder of ChatGPT and creator of OpenAI speaks at University College ...

Associated Press

Artificial intelligence threatens extinction, experts say in new warning

Scientists and tech industry leaders issued a new warning Tuesday about the perils that artificial intelligence poses to humankind.

3 days ago

Sponsored Articles

Men's Health Month...

Men’s Health Month: Why It’s Important to Speak About Your Health

June is Men’s Health Month, with the goal to raise awareness about men’s health and to encourage men to speak about their health.

Internet Washington...

Major Internet Upgrade and Expansion Planned This Year in Washington State

Comcast is investing $280 million this year to offer multi-gigabit Internet speeds to more than four million locations.

Compassion International...

Brock Huard and Friends Rally Around The Fight for First Campaign

Professional athletes are teaming up to prevent infant mortality and empower women at risk in communities facing severe poverty.

Emergency Preparedness...

Prepare for the next disaster at the Emergency Preparedness Conference

Being prepared before the next emergency arrives is key to preserving businesses and organizations of many kinds.

SHIBA volunteer...

Volunteer to help people understand their Medicare options!

If you’re retired or getting ready to retire and looking for new ways to stay active, becoming a SHIBA volunteer could be for you!

safety from crime...

As crime increases, our safety measures must too

It's easy to be accused of fearmongering regarding crime, but Seattle residents might have good reason to be concerned for their safety.

Treasury bond yield inversion raises worries over recession