‘A powerful signal of recessions’ has Wall Street’s attention
You can try to play down a trade war with China. You can brush off the impact of rising oil prices on corporate earnings.
But if you’re in the business of making economic predictions, it has become difficult to disregard an important signal from the bond market.
The so-called yield curve is perilously close to predicting a recession — something it has done before with surprising accuracy — and it’s become a big topic on Wall Street.
The term “yield curve” can be eye-watering if you’re not a bond trader, but the mechanics, practical impact and psychology of it are fairly straightforward.
Here’s what the fuss is all about.
The mechanics
The yield curve is basically the difference between interest rates on short-term U.S. government bonds, say, two-year Treasury notes, and long-term government bonds, like 10-year Treasury notes.
Typically, when an economy seems in good health, the rate on the longer-term bonds will be higher than short-term ones. The extra interest is to compensate, in part, for the risk that strong economic growth could set off a broad rise in prices, known as inflation. Lately, though, longterm bond yields have been stubbornly slow to rise — which suggests traders are concerned about long-term growth — even as the economy shows plenty of vitality.
At the same time, the Federal Reserve has been raising shortterm rates, so the yield curve has been “flattening.” In other words, the gap between short-term interest rates and long-term rates is shrinking.
On Thursday, the gap between two-year and 10-year U.S. Treasury notes was roughly 0.34 percentage points. It was last at these levels in 2007 when the U.S. economy was heading into what was arguably the worst recession in almost 80 years.
As scary as references to the financial crisis makes things sound, flattening alone does not mean that the United States is doomed to slip into another recession. But if it keeps moving in this direction, eventually longterm interest rates will fall below short-term rates.
When that happens, the yield