Written by STAN CHOE-AP Business Writer
(AP) — The scent of a possible recession is wafting through the bond market again.
Bonds are supposed to be the boring corner of the finance world, but even high-flying stock investors stop and pay attention when they fall into a particular, concerning pattern. It’s called an “inverted yield curve,” and it happens when yields for short-term U.S. government debt rise above yields for longer-term debt. It’s been a relatively reliable predictor for recessions, though not a perfect one, and it’s happening again.
A Treasury maturing in three months is yielding 2.35%, more than the 2.25% offered by a Treasury maturing a decade from now. The reverse of that is more typical because investors usually demand higher yields for locking their money away for longer periods of time. This part of the yield curve, the three-month Treasury compared against the 10-year Treasury, has been inverted for about a week. It also had been inverted briefly in late March.
Because the warning signal has a fairly accurate track record. Each of the last seven recessions, stretching back to the 1969-70 downturn, was preceded by the 10-year yield falling below the three-month yield, according to the Federal Reserve Bank of Cleveland. A rule of thumb says an inverted yield curve suggests a recession in about a year.
Before March, the last time a three-month Treasury yielded more than a 10-year Treasury was in late 2006 and early 2007, before the Great Recession made landfall in December 2007.
WHY DID THE YIELD CUVE INVERT?
When a bond’s price rises, its yield falls, and prices have been jumping for longer-term Treasurys as investors look for safe places to park their money.
Worries about the U.S.-China trade war have flared up, and many investors are anticipating that the path to a resolution will longer and messier than they were expecting just a few weeks ago.
The yield on the 10-year Treasury has dropped more than a quarter of a percentage point from 2.52% earlier this month, when a tweet from President Donald Trump shattered the market’s calm by threatening to impose more tariffs on China.
Shorter-term Treasury yields, by contrast, are influenced less by investors and more by the Federal Reserve, which raised its benchmark short-term rate seven times over the past two years. Those rate hikes forced the three-month yield as high as 2.46% in March, up from 1.88% a year ago.
Momentum has slowed, though, because the Fed said it would be more patient in raising rates, and many investors expect its next move to be a cut to interest rates. That has helped the three-month Treasury yield drift back to 2.35%, but the 10-year yield has fallen more dramatically.
IS IT A PERFECT PREDICTOR?
No, an inverted yield curve has sent false positives before. The yield curve inverted in late 1966, for example, and a recession didn’t hit until the end of 1969.
Some market watchers also suggest an inverted yield curve offers less of a signal than it used to, mostly because herculean efforts by central banks to keep interest rates low and help their economies are distorting yields.
Bonds in Europe and Japan have been offering negative yields, which has pushed bond investors from those countries into longer-term U.S.
Treasurys, which in turn pulls down their yields.
HAVEN’T WE HEARD THIS BEFORE?
Besides March, when the three-month yield briefly rose above the 10-year yield, other parts of the yield curve have also inverted. Late last year, for example, the five-year Treasury’s yield dropped below the three-year yield.
Those parts of the yield curve, though, aren’t as closely watched.
And not every part of the yield curve is inverted. Many traders on Wall Street also pay close attention to the difference between two-year and 10-year Treasurys. That part of the curve is still not inverted. The 10-year yield of 2.25% is still above the two-year yield of 2.10%.
SO IS A RECESSION COMING OR NOT?
It’s too soon to say. Job growth is still solid, and consumer confidence remains high. But investors are taking notice.
“When anything in life is kinked or inverted, it’s not a good thing, especially when it happens to the yield curve,” said Rich Weiss, chief investment officer of multi-asset strategies at American Century Investments. “That’s starting to presage less than favorable things for the economy.”