Yield Curve Inversion: Sign of a US Recession?
The US Treasury bond yield curve has recently inverted, with the two-year yield at 4.96% surpassing the ten-year yield at 3.96%. This puts the spread at a negative 100 basis points, marking the largest gap since 1981 and signaling the potential for an economic recession in the United States, as historical data suggests.
A trip down memory lane to May 1981 reveals a stark parallel. Back then, the spread between the two-year and ten-year US Treasury bond yields plunged to negative 170 basis points. Shortly thereafter, the US economy descended into a recession that spanned from July 1981 to November 1982. At one year and four months, this downturn was the lengthiest of its time.
Fast-forward to 2020, during the grip of the COVID-19 pandemic, the yield gap contracted to a mere negative 5 basis points. This led to a relatively shorter recessionary period. Other historical instances, such as the dot-com bubble, also demonstrate a correlation between the inversion of the yield curve and economic recessions in the United States.
This brings us to the pressing questions of today: Is the US economy on the cusp of a recession? If so, when will it hit? How long will it last, and what severity can we expect?
It’s imperative to recognize that these questions have no clear-cut answers, particularly given the current mixed bag of US economic data. For instance, the Manufacturing Purchasing Managers’ Index (PMI) from the Institute for Supply Management (ISM) for June contracted to 46.0 points, falling short of market projections of 47.2 points. This has amplified concerns regarding the US’s vulnerability to a looming recession. Conversely, other indicators such as consumer confidence, gross domestic product, unemployment claim rates, and more, have outperformed market expectations and previous readings.
Furthermore, it's important to highlight that the two-year US Treasury yield is acutely sensitive to hikes in interest rates. Each time the Federal Reserve signals a potential interest rate increase – which is anticipated to occur at least twice this year – the two-year yield responds by climbing.
In conclusion, as we navigate through these precarious financial waters, vigilance and astute analysis of economic indicators will be essential in preparing for what the future holds.
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Please note that this analysis is provided for informational purposes only and should not be considered as investment advice.
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