Is the Bond Market Signaling a Recession?

Tom Gentile

Posted in
Big Picture

By: Tom Gentile
March 28th, 2022

2 mins read

Inverted Yield Curve and What it May Bring

An inverted yield curve in bonds is where or when short-term bond yields exceed those of longer-term bond yields. It signals investors are worried about the economy’s long-term potential.

An example of this is a 20-year Treasury bond carrying a higher yield (or, interest rate) than a one-year.

Investors expect a larger return when they lend their money for a longer time period. This results in giving the “yield curve” its upward sloping shape.

What Happens When the Yield Curve Inverts?

When the curve inverts meaning the short-term bonds are now paying a higher yield than long-term bonds it causes a distortion, if you will, in the market.

Hard Landing vs. Soft Landing

Interest rates are affected by the decision of the Federal Reserve and where they set their interest rate marker on short-term interest rates. Their decisions have more affect on the short-term rates vs. the long-term ones.

The Fed raised rates for the first time in over 3 years  to help battle inflation which is/was at a 40-yr-high in March. Not only are more expected, but Fed Chair Powell says he may raise them at a rate of a half-basis point if need be.

The concern is for a so-called “hard landing.” A hard landing is one where the Fed raises interest rates too aggressively and accidentally triggers a recession.

The ideal situation would be one of a s-called “soft landing.”  This would be where the Fed reduces inflation, and we don’t experience an economic contraction.

Part of the Bond Market Inverted, but not the Most Watched

The most aid attention to spread in bonds that Investors pay attention to is the spread between the 2-year U.S. Treasury and the 10-year U.S. Treasury. Thus far that curve hasn’t inverted and hasn’t flashed a warning sign yet.

Do note the 5-year and 30-year U.S. Treasury yields inverted on Monday. The reason this is grabbing some attention is this hasn’t happened since 2006, before the Great Recession.

Yield curve inversions have happened multiple times over the years, but many economists I am reading say it doesn’t mean a recession is imminent.

 Sounds good to me, but I don’t want any of us caught off guard, so I bring this education to your attention.

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