The Federal Reserve’s favorite recession indicator is flashing a danger sign again
The 10-year Treasury yield passed below that of the 3-month note in trading Wednesday. In market lingo, that’s known as an “inverted yield curve,” and it’s had a sterling prediction record over a 12- to 18-month timeframe for downturns going back decades.
In fact, the New York Fed considers it such a reliable indicator that it offers monthly updates on the relationship along with percentage odds on a recession occurring over the next 12 months.
At the end of January, when the 10-year yield was about 0.31 percentage point clear of the 3-month, the probability was just 23%. However, that is almost certain to change as the relationship has shifted dramatically in February. The reason the move is considered a recession indicator is the expectation that the Fed will cut short-term rates in response to an economic retreat in the future.
-0.06 (-842.86%)“This is what one would expect if investors are adopting a much more risk-averse attitude set of behavior due to a growth scare, which one periodically sees late in business cycles,” said Joseph Brusuelas, chief economist at RSM. “It’s not clear yet whether it’s more noise or it’s a signal that we’re going to see a more pronounced slowdown in economic activity.”
Though markets more closely follow the relationship between the 10- and 2-year notes, the Fed prefers measuring against the 3-month as it is more sensitive to movements in the central bank’s federal funds rate. The 10-year/2-year spread has held modestly positive, though it also has flattened considerably in recent weeks.
-0.02 (-10.40%)To be sure, yield curve inversions have had a strong but not perfect forecasting history. In fact, the previous inversion happened in October 2022, and there’s still been no recession 2½ years later.
So while there’s no certainty that growth will turn negative this time around, investors worry that expected growth from an ambitious agenda under President Donald Trump may not happen.
Economic obstacles arising
The 10-year yield soared following the Nov. 5, 2024, presidential election, building on gains that began when Trump moved higher in the polls in September and peaking about a week before the Jan. 20 inauguration. That would normally be a telltale sign of investors expecting more growth, though some market pros saw it also as an expression of worries over inflation and the extra yield investors were demanding from government paper amid a mounting debt and deficit issue for the U.S.
Since Trump took office last month, yields have tumbled. The 10-year has fallen about 32 basis points, or 0.32 percentage point, since the inauguration as investors worry that Trump’s tariff-focused trade agenda could spike inflation and slow growth. The benchmark yield is now essentially unchanged from Election Day.
De-Dollarization:
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