Investors are concerned that the yield curve may eventually reverse as the spread narrows. That is, short-term interest rates will be higher than long-term interest rates. As of Friday, the difference is only 0.25% and the 10-year yield is about 2. % And a two-year yield of 1.75%.
Monday’s gap widened a bit, rising to 2.1% in 2010, yields rising to about 1.82% in two years, and spreads to 0.28%.
Yield curve reversals are often a sign of a potential recession. The yield curve reversed in 2019, before the recession by Covid in 2020. It also reversed in 2007, before the 2008 global financial crisis / depression. It also turned around in early 2000. Dot-com / tech stock meltdown.
U.S. Secretary of Labor Marty Walsh told CNN Poppy Harlow that the recession was a “real possibility,” but added that “we have a very strong economy,” especially employment. He said the market was healthy.
If investors want to raise interest rates on short-term bonds, it indicates that bondholders are nervous. Interest rates on long-term bonds are usually higher due to the longer waiting times for repayment.
So how much should investors be concerned about the potential yield curve reversal?
Some argue that the only reason this is happening is due to Russia’s invasion of Ukraine and the consequent rise in commodity prices.
“The risk of a recession is increasing, but not necessarily immediately unless global geopolitics deteriorates dramatically from this delicate starting point,” said Deutsche Bank strategist Jim Reed.
The Fed, which is widely expected to raise interest rates later this week, should be careful not to raise interest rates so aggressively that short-term interest rates will rise further and the yield curve will reverse.
It can cause a slowdown in the job market, and the Fed should be on the lookout for unemployment and inflation.
“Chair [Jerome] Powell said the Fed is aware of its dual mission and will reveal that it does not want to reverse the yield curve and cause a recession. ”
Inflation concerns existed before Russia-Ukraine
Geopolitical tensions could distort prices, but inflationary pressures were already high before Russia attacked Ukraine.
“Russia / Ukraine is only advancing the natural slowdown in the economy that would have occurred when the Fed tightened its policies,” said Tom Essay, founder of Seventh Report Research, in a memo last week. “.
Essaye argues that even if Russia and Ukraine aren’t listed in the headlines, the Fed’s rate hikes and economic slowdown are likely to reverse the yield curve at some point later this year.
“The looming rate hike, coupled with the urge to slow growth by rising commodity prices and rising inflation, will slow growth faster than previously expected,” he said.
Rising short-term interest rates can also cause problems for large Wall Street companies. Higher interest rates tend to increase the profits of loans, but especially bond trading is also gambling.
“Recent yield curve flattening and capital market volatility are new risks, so we’re more cautious with big banks,” an analyst at research firm KBW said in a recent report.
The fact that bond yields are low is not necessarily a bad thing. Traders clearly feel that US Treasuries are stable enough to keep flocking to it, as interest rates fall when investors buy bonds. Periodic interest rates reduce this significantly.
One strategist said it doesn’t matter if investors buy the bond because they recognize it as safe. I still have a lot to worry about.
“The recessionary drum beats are increasing in volume,” said Nancy Tengler, CEO and Chief Information Officer of Laffer Tengla Investments. Eurozone and dangerously flat yield curve. ”
“Don’t worry about the yield curve being distorted by a large flight to quality. The reversal is a reversal,” Tengler added.