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Inverted US Treasury Yield Curve Weakens, Is a US Economic Recession Imminent? - Huxiu.com#
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Under normal circumstances, long-term US Treasury yields are higher than short-term yields because long-term inflation and interest rate uncertainties are higher than short-term ones, so bond investors tend to demand higher yields. ⤴️ ^d3baf288
This explains why long-term US Treasury yields are generally higher than short-term yields. However, currently, short-term yields are higher than long-term yields, which to some extent indicates that the market believes that short-term risks are greater than long-term risks. This largely proves the market's pessimism and is therefore one of the indicators of an economic recession.
It is important to understand how the degree of the inverted yield curve is weakening. There are two possibilities for this situation: either the decline in the two-year Treasury yield is faster than the ten-year Treasury yield, or the rise in the ten-year Treasury yield is faster than the two-year Treasury yield. Both cases lead to a steepening yield curve, with the former referred to as "bull steepening" and the latter as "bear steepening".
Under "bull steepening," it usually indicates that the market is digesting expectations of an upcoming interest rate cut by the Federal Reserve, resulting in a significant drop in short-term yields, which typically occurs before an economic recession. ⤴️ ^e86f016c
The current "bear steepening" of the yield curve is driven by the resilience of the economy and the labor market, leading to an increase in long-term yields because investors expect the Federal Reserve to maintain high interest rates for a longer period of time. This implies a more restrictive financial environment, rising borrowing rates, and increased competition for other assets, which in turn increases the possibility of a weakening labor market and an economic recession. ⤴️ ^b6cd5045
"Bear steepening" means that the growth rate of interest expenses for individuals and businesses borrowing is faster than the return on cash equivalents, resulting in an increase in net interest expenses, which weighs on the overall economy. ⤴️ ^01115304
"Bear steepening" usually occurs at the beginning of an economic cycle, when the yield curve becomes steeper in an already inverted state, indicating that an economic recession is imminent or has already begun. Generally, this is followed by a significant decline in long-term government bond yields and stock indices. ⤴️ ^1cf30f70
Inverted US Treasury Yield Curve Weakens, Is a US Economic Recession Imminent?#
One of Wall Street's most closely watched indicators for predicting an economic recession, the degree of the inverted yield curve, is weakening. However, this is not entirely good news for investors, and it is important to understand how the degree of the inverted yield curve is weakening.
Since July 2022, the US Treasury yield curve has been inverted, with long-term yields lower than short-term yields. Under normal circumstances, long-term US Treasury yields are higher than short-term yields because long-term inflation and interest rate uncertainties are higher than short-term ones, so bond investors tend to demand higher yields.
However, over the past 15 months, investors have been digesting expectations of rising short-term rates and increasing economic risks, leading to an inverted yield curve. Historically, the inverted yield curve has been a reliable indicator of an economic recession. Since the 1950s, the US economy has experienced a recession every time the yield curve inverted. According to Dow Jones market data, after the yield curve inverted, the shortest time for an economic recession to occur was seven months, and the longest was two years.
In early July of this year, the two-year Treasury yield was nearly 1.1 percentage points higher than the ten-year Treasury yield, marking the deepest inversion of the yield curve since the Silicon Valley Bank's bankruptcy in early March, approaching levels seen in the 1970s and 1980s.
Currently, the difference between the two-year Treasury yield and the ten-year Treasury yield has narrowed to 0.29 percentage points, with the former at 5.07% and the latter at 4.78%. Other parts of the yield curve are no longer inverted: the 30-year Treasury yield is 4.94%, higher than the yields of the 3-year, 5-year, and 10-year Treasury bonds. Currently, the highest yield is on the 6-month Treasury bond, at 5.58%.
It is important to understand how the degree of the inverted yield curve is weakening. There are two possibilities for this situation: either the decline in the two-year Treasury yield is faster than the ten-year Treasury yield, or the rise in the ten-year Treasury yield is faster than the two-year Treasury yield. Both cases lead to a steepening yield curve, with the former referred to as "bull steepening" and the latter as "bear steepening".
Under "bull steepening," it usually indicates that the market is digesting expectations of an upcoming interest rate cut by the Federal Reserve, resulting in a significant drop in short-term yields, which typically occurs before an economic recession.
The current "bear steepening" of the yield curve is driven by the resilience of the economy and the labor market, leading to an increase in long-term yields because investors expect the Federal Reserve to maintain high interest rates for a longer period of time. This implies a more restrictive financial environment, rising borrowing rates, and increased competition for other assets, which in turn increases the possibility of a weakening labor market and an economic recession.
Tan Kai Xian, an analyst at Gavekal Research, said, "The overall impact of 'bear steepening' will be to increase net interest expenses for non-financial companies in the United States. At such cyclical junctures, higher net interest expenses will weigh on corporate profits and prompt profit-focused companies to lay off employees."
Individuals and businesses tend to borrow for the long term, such as 30-year mortgages or 10-year corporate bonds, while holding cash in short-term instruments. Therefore, "bear steepening" means that the growth rate of interest expenses for individuals and businesses borrowing is faster than the return on cash equivalents, resulting in an increase in net interest expenses, which weighs on the overall economy.
Historically, the "bear steepening" phase is much rarer than the "bull steepening" phase.
Jonas Goltermann, Deputy Chief Market Economist at Capital Economics, said, "The 'bear steepening' usually occurs at the beginning of an economic cycle, when the yield curve becomes steeper in an already inverted state, indicating that an economic recession is imminent or has already begun. Generally, this is followed by a significant decline in long-term government bond yields and stock indices."
In other words, if the fear of an economic recession drives increased interest in long-term US Treasury bonds on Wall Street and prompts the Federal Reserve to lower short-term interest rates, the "bear steepening" could still turn into "bull steepening." This situation would not occur without some "pain" for the US economy.
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