The yield curve signals: Fed moves in the US will stifle the economy

One of the indicators of a future recession, which can be deduced from trading in the US government bond market, is back This week for the first time since 2019, in the midst of the US-China trade war, and a year before the Corona crisis.

Yield curve (Yield Curve), which reflects the gap between the yield given by the US government bond for 10 years, and the yield on the government bond for two years – reversed, after the bond yield paths of the two crossed at a level of about 2.39%.

The yield curve is an important indicator, which indicates investors’ expectations regarding the state of the economy. In ordinary days, the longer the maturity of the bond, the higher the yield, since when the economy grows alongside demand, this is reflected in upward price pressure expectations, or in other words: inflation.

But when inflation exceeds the targets set by central banks, as is happening today, and needs to be curbed, banks raise interest rates. But unlike in the past, inflation, which was considered temporary until recently, has risen at an alarming rate in recent months, and there is concern that the Fed has delayed the train when it delayed raising interest rates. There are now fears in the market that the increases will be at a rapid pace, which will weigh on the economy, so much so that the Fed will have to go back and lower interest rates in the not too distant future.

On routine days, the return to investors in the long run is higher than the return in the short run, so the curve tends to climb upwards. But the curvature of the curve reflects a situation in which investors estimate that the Fed’s move to curb expansionary policies, by raising interest rates, could stifle the economy to the point of a continued slowdown in growth. That is, investors do not attribute a high chance to the possibility that the Fed will be able to moderate inflation and evade the slowdown, which will force it to lower interest rates again later.

Decrease in yields against the background of declining commodity prices

Earlier this week, the yield curve between 30-year and 5-year yields was reversed, for the first time since 2006. Now, as mentioned, even the two-year short yields have outperformed the longer-year 10-year bond yield.

The latter fell against the background of falling commodity prices this week, when the price of oil fell to around $ 100 a barrel, amid reports of progress between Russia and Ukraine. That is, according to the bond market, the US economy may be heading for recession.

The capital market reflects the expectations of investors for the future. Thus, the reversal of the yield curve in terms of the market means that the rising economic (cycle) cycle of interest rates, which only began about two weeks ago in the US. Lower the interest rate.

The reversal of the yield curve is considered a leading indicator of a recession, but does not necessarily accurately schedule the arrival of the recession. For example, the crooked reversal appeared in 2006, warning of a subprime crisis. However, according to the Bank of America, the reversal of the yield curve predicted seven of the nine recessions previously recorded in the U.S. economy.

The yield curve began to flatten even before the reversal recorded this week, as early as February when Fed Chairman Jerome Powell said the central bank might start to shrink its balance sheet as early as this year. Since then, the Fed has raised interest rates by 0.25%, and Powell The Fed’s monetary policy will be strengthened, in order to curb inflation, and will not rule out the possibility of higher interest rates, but rather the debt market will signal a halt to it, as the move will “suffocate” the economy.

At the same time, along with the slowdown in growth, this trend may also curb inflation, thus doing the job for central banks, which have changed policy more quickly than expected, in order to curb inflation. Just last November, Powell called for abandoning the “temporary” notion of inflation, and now, unexpectedly, it has risen to 7.9% in February, and is expected to continue to climb amid fluctuations in the commodity market.

By Editor

Leave a Reply