The spread between 5-year and 30-year Treasury yields briefly inverted on Monday for the first time since 2006 on fears that the Fed’s aggressive approach to tackling the highest inflation in four decades could lead to a sustained slowdown in growth. .
Yields on the 5-year Treasury note rose to 2.63% on Monday, outperforming those on 30-year notes (which fell to around 2.60%). The spread between the 5-year and 10-year Treasury inverted earlier this month.
Yield curve inversions, which are rare, are considered a good recession predictor because they suggest that investors believe that, with the interest rate on long-term bonds lower than the rate on short-term bonds, economic growth is slowing.
“Markets are obsessed with the US Treasury yield curve as it is seen as an excellent indicator of the economy,” said Anu Gaggar, global investment strategist at Commonwealth Financial Network. “If the economy is healthy and growing, longer-term Treasury rates should be higher than shorter-term rates. When the opposite is true, concerns about the future state of the economy begin to mount.”
The more closely watched spread between 2-year and 10-year note yields is also narrowing, falling from a high of 1.56% to less than 0.2% in the span of just one year. It’s the flattest the spread has been in two years, before the pandemic took hold and triggered an extremely deep but short-lived recession.
Every recession in the last 60 years was preceded by an inverted yield curve, according to research of the Federal Reserve Bank of San Francisco.
The bond market move comes as the Fed takes a more aggressive approach to fighting inflation: Policymakers raised rates by a quarter percentage point two weeks ago and have since signaled support for a faster hike. half a percentage point at its May meeting.
“If we conclude that it is appropriate to act more aggressively by raising the fed funds rate by more than 25 basis points in a meeting or meetings, we will do so,” Chairman Jerome Powell said last week during an economic conference. “And if we determine that we need to toughen beyond common neutrality measures and take a more restrictive stance, we will do that as well.”
The Department of Labor reported earlier this month that the consumer price index rose 7.9% in February from a year earlier, marking the fastest increase since January 1982, when inflation hit 8.4%. The CPI, which measures a bundle of goods ranging from gasoline to health care, rose 0.8% from January.
Some economists believe the Fed waited too long to deal with the burst of inflation, while others have raised concerns that moving too quickly to stabilize prices risks triggering an economic downturn. Rising interest rates tend to lead to higher rates on business and consumer loans, slowing down the economy by forcing employers to cut spending.
Still, Powell has pushed back against concerns that an inverted yield curve indicates the economy is headed for a recession and remained optimistic that the Fed can strike a delicate balance between reining in inflation without crushing the economy.
“The likelihood of a recession in the next year is not particularly high,” Powell told reporters two weeks ago, citing the strong job market, strong payroll growth and strong balance sheets for businesses and households. “Everything indicates that it is a strong economy and that it will be able to prosper in the face of a less accommodative monetary policy.”