Yield Curve Inversion Could Be Harbinger Of Recession

On March 29, the yield on the two-year Treasury note briefly surpassed the yield on the benchmark 10-year note, marking the first time it has inverted since September 2019. This may be a reflection of a fear in the market that the Federal Reserve could push the economy into a recession as it raises interest rates to combat rapidly rising inflation.

While the short-term inversion in August and early September 2019 was followed by a significant downturn in 2020, it is difficult to know whether this downturn would have occurred if it hadn’t been for the unforeseen closure of businesses, dramatic increase in the unemployment rate, and the economic collapse that came as a result of the worldwide COVID-19 pandemic.

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Still, many view an inversion of the yield curve as a reliable signal that a recession is imminent in the following year or two.

The Fed has been aggressively hiking interest rates to fight soaring inflation, and investors are now worried that this will dent economic growth.

“The movements in the twos and the tens are a reflection that the market is growing nervous that the Fed may not be successful in fostering a soft landing," said Joe Manimbo, Senior Market Analyst at Western Union Business Solutions.

Some analysts are claiming that the Fed’s huge bond purchases have distorted the yield curve, and that this is holding down long-dated yields relative to shorter-dated ones.

The sanctions imposed on Russia by Western nations after its invasion of Ukraine have certainly not helped the situation, creating more volatility in commodity prices and adding to already high inflation.

Regardless of whether those who support this theory that an inverted yield curve can reliably predict a recession are correct, the lag time between an inversion of the two-, 10-year part of the curve and a recession is usually fairly long. Therefore, an economic downturn is not necessarily an immediate concern.

"The time delay between an inversion and a recession tends to be, call it anywhere between 12 and 24 months. Six months has been the shortest and 24 months has been the longest, so it’s really not something that is actionable for the average folks," said Art Hogan, Chief Market Strategist at National Securities in New York.

Investors and average folks alike will just have to wait and hope the Fed deals with inflation in an efficient and sensible manner.