Inverted U.S. yield curve returns, biggest recession warning sign since 2007

inverted yield curves

Earlier in 2019 much fuss was made over the inversion of the short-term, three-month bonds and 10-year treasury notes, where the shorter-term note ended up crossing over the yield of its longer cousin. The reason this is such a big deal is that inverted yield curves have successfully predicted every recession in recent history.

With investor paranoia growing that a potential downturn is overdue considering how long the stock market has been in a bull market, this piece of news was enough to lead to a flurry of worries.

However, this dreaded indicator returned on Wednesday, with the discrepancy between the two yields growing to the highest it’s been since the 2007 financial crisis.

The bears on Wall Street have certainly had a good day on Wednesday. Global economic fears have grown recently with the escalating trade war, with President Trumps proposed tariffs being poorly received by investors while China has some potential avenues of retaliation (such as the rare earth industry, whom the U.S. is entirely dependent on continued imports).

Prices of gold and other vehicles to store wealth have also jumped on Wednesday in response to these fears. But among all these factors in play, the return of the inverted yield curves was arguably the biggest factor affecting markets today.

The yield on three-month US treasury notes traded as much as 41.2 basis points above the benchmark 10-year government note, the widest gap between the two seen since 2007. While this gab fell over the course of the day as U.S. stock prices recovered and the bond market rally lost steam, the persistence of this dreaded sign is fueling anxieties in the global financial markets.

“The next recession couldn’t have been better telegraphed,” said Mark Holman at TwentyFour Asset Management according to The Financial Times. “There is a trade war between the two global superpowers with both sides digging in their heels and the clock is ticking towards a hard Brexit, so it really does make sense to take risk off the table.”

At the same time, other experts worry that the message being sent by the markets here is that the Federal Reserve is moving too slowly and falling behind on developments. While it’s true that a central bank can’t respond to every threat or development in the global markets as that would destabilize monetary policy, there are some voices in the financial community who think the Fed isn’t doing enough.

Either way, the return of the inverted yield curve is bad news for investors. However, that’s not to say there aren’t some investors who disregard the indicator altogether. Earlier this year, Daniel Ivascyn, chief investment officer of the world’s largest bond trader, Pacific Investment Management Company (Pimco), went on to say that the markets are overly anxious about potential recessionary signals. Others go on to dismiss the significance of the curve completely, saying that it’s a product of coincidence, that if one looks hard enough, they will eventually find some metric or indicator that happens to fit all the past data points in question (in this case, being recession).

Time will tell whether the inverted yield curve will be proven right again. Until then, investors remained worried for a while longer yet, hoping that we will only have to deal with a soft recession rather than anything more extreme.