The Bond Market is Signaling a Recession

The Bond Market is Signaling a Recession

In normal conditions, the long-term US treasury notes yield is above the short term one, however, lately the former has been behind the later, a rare phenomenon which is usually associated with an increased risk of recession. The last time we got a yield curve inversion was in 2007, a year before the fall of Lehman Brothers.

When uncertainty and fear grow among investors, they usually leave risky assets for treasuries, increasing the demand for bonds and driving down the long-term yield. In fact, the 10-year yield decreased to 2.43 percent from the 3.20 percent reported at the end of last year.

Shorter-term rates are more sensitive to interest rate increases, for example, the three-month yield went up to 2.45 percent from 1.71 percent a year ago, mostly driven by the continuous Federal Reserve rate hikes in the last two years.

Yield curve inversions are often associated with an economic slowdown, as the last nine times, the phenomenon a recession followed.

However, the American economy is still showing healthy signs, with record employment levels and wages increasing and even though such a relationship exists, sometimes curve inversions are not perfect recession predictors. These contradicting signs are also supporting the Federal Reserve’s late flexibility.

Experts may need to reassess their economic forecasts, especially the Federal Reserve, which is projecting a 2,1% percent economic growth for this year. As reported by other sources and suggested by some economists the experts have often been too optimistic, having to constantly readjust their economic forecasts.

One of the most popular explanations of this phenomenon is that instead of being amid an economic boom we were instead in the middle of what the economist Lawrence Summers called “secular stagnation” in his speech at the International Monetary fund in 2013, previously put forth by the economist Alvin Hansen in 1938.

Even though the idea is controversial, the imbalance between low investment levels and households savings despite the low-interest rate levels may strengthen this explanation.

It is probably too soon to determine if we are going towards a recession or not. It’s also likely that the constant warnings from experts are increasing anxiety among investors, which in turn would push the economy towards a self-fulfilling economic crisis.