Yield curve inversion: Are recession fears valid?

By MarketsFOXBusiness

New fears inverted yield curve could predict recession to come

Barron's senior reporter Mary Childs and former Dallas Fed adviser Danielle DiMartino Booth on concerns over a potential U.S. recession.

There’s increasing talk about the prospect of a pending recession following recent movement in the U.S. bond market – but panicking may be premature.

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The spread between the 3-month and 10-year treasury note yields inverted on Friday – which means the yield on the 10-year fell below the 3-month – for the first time since 2007.

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Yield curve inversion has typically been considered an indicator of recession because it means the interest rate on long-term bonds is lower than the rate on short-term bonds – which can signal that buyers think the economy is on a downward trajectory.

But experts caution investors against starting to panic.

“The price action of bonds has always been a strong leading indicator of future economic activity – albeit it’s not absolute – nothing is perfect,” Chad Morganlander, senior portfolio manager at Washington Crossing Advisors, told FOX Business.

While Morganlander noted the signal is telling investors that a slowdown of the U.S. economy – and the global economy – is happening, he noted it should be interpreted more as a “fire alarm” for investors to be a bit more cautious and balanced in their approach to the markets. That’s because an inversion does not indicate when a slowdown could happen – or even how severe it might be.

The past three times the 10-year yield fell below the three-month yield, a recession has followed.

The spread between the 3-month and 10-year notes is a closely watched gap – though the spread between the 2- and 10-year is also closely followed. That, too, is also flattening. A flattening yield curve generally indicates weak economic growth compared to a steep curve, which indicates strong growth.

The bond market movement came days after the Federal Reserve reduced its growth outlook and projections for interest rate hikes. The central bank, which estimated in December it would raise the benchmark federal funds rate two times in 2019, said it may not hike rates at all this year – upping demand for government bonds.

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A yield curve inversion can also signal expectations that the Federal Reserve is about to cut interest rates.

In response to the situation, Dallas Fed President Robert Kaplan said it was too soon to consider slashing rates during an interview with The Wall Street Journal. Kaplan said the inversion would need to last for months before he would consider changing that position.