The move ushers in fresh questions about the Fed and the economy.
The U.S. Treasury yield curve just inverted for the first time in more than a decade.
It’s a moment that the world’s biggest bond market has been thinking about for the past 12 months. I wrote around this time last year that Wall Street had come down with a case of flattening fever, with six of the 11 analysts I surveyed saying that the curve from two to 10 years would invert at least briefly by the end of 2019. That’s not exactly what happened Monday, though that spread did reach the lowest since 2007. Rather, the difference between three- and five-year Treasury yields dropped below zero, marking the first portion of the curve to invert in this cycle.
The move didn’t come out of nowhere. In fact, I wrote a week ago that the spread between short-term Treasury notes was racing toward inversion, and Bloomberg News’s Katherine Greifeld and Emily Barrett noted the failed break below zero on Friday. Still, I wasn’t necessarily expecting this day to come so soon. Rate strategists have long said that being close doesn’t cut it when talking about an inverted yield curve and the well-known economic implications that come with it, namely that the spread between short- and long-term Treasury yields has dropped below zero ahead of each of the past seven recessions.
It’s important to keep in mind the timeline between inversion and economic slowdowns — it’s not instantaneous. The yield curve from three to five years dipped below zero during the last cycle for the first time in August 2005, some 28 months before the recession began. That this is the first portion to flip isn’t too surprising, considering how much scrutiny bond traders place on the Federal Reserve’s outlook for rate increases. All it means is that the central bank will probably leave interest rates steady, or even cut a bit, in 2022 or 2023. I’d argue that’s not just possible, but probable, given that we’re already in one of the longest economic expansions in U.S. history.
The more interesting question might be why this part of the yield curve won the race to inversion, rather than the spread between seven- and 10-year Treasuries, which looked destined to fall below zero earlier this year. One reason could be that the Fed’s balance-sheet reduction is putting more pressure on 10-year notes than shorter-dated maturities, which wasn’t the case during past periods of inversion. Indeed, policy makers have shown no signs of easing up on this stealth tightening.
On top of that, the Treasury Department is selling increasing amounts of debt, which disproportionately affects the longest-dated obligations because buyers have to consider the duration risk they’re absorbing. Remember the curve from five to 30 years, which fell below 20 basis points in July? That spread is about 46 basis points now, driven by stubbornly higher long-bond yields.
Given the recent pivot from the most important Fed leaders — Jerome Powell, Richard Clarida and John Williams — this flirtation with inversion among two-, three- and five-year Treasury notes probably isn’t going away. The bond market is fast approaching the point where traders have to ask themselves whether a rate hike now increases the chance of a cut in a few years. Other questions include “What is neutral?” and “Can the Fed engineer a soft landing?” To say nothing about whether the assumed relationship between the labor market and inflation expectations is still intact.
Those are big questions without easy answers, and the first inversion of the U.S. yield curve offers only one clue. The Fed wants to be more data dependent going forward. Odds are the market will do the same.
-Brian Chappatta, Bloomberg
My take: So in simple terms what is going on with an inverted bond-yield curve?
When the curve becomes inverted it means more would be stock investors are running to buy bonds because they see significant weakening in the market ahead on top of the Fed's rising interest rates. If you think the market is going to do well you invest in stocks to benefit from rising stock prices, if you don't you buy bonds as the safe haven in a falling market assuming people will put their money somewhere and they usually do. Both stocks and bonds accrue value but stocks accrue more value quicker but with risk of loss and bonds more slowly as borrowed interest with no risk of loss unless the U.S. government itself goes down and then it wouldn't matter anyway. Bonds are bought on longer term commitment mostly from the government and the government pays you interest for using your money.
Stock investors watch the bond yield chart but it usually is uneventful. When the chart curve finally inverts it is a major technical and fundamental indicator of market sluggishness ahead or even a serious market pullback. It is one of the most highly regarded market warning indicators and when investors see it invert they sell their stocks to get out of a feared market collapse. As so often is the case with these indicators it becomes a self-perpetuating crisis feeding off human nature. You will see it mentioned quickly on the internet but you'll not see much mention of it in the nightly business news because it is a flash point trigger such that talk of it can cause a full blown stampede of the herd. They will cover all market analysis that has everything to do within and without the bond yield curve but they dare not rattle the pots and pans too loudly.
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