The bond market is feeling the recession. On Friday, stock investors also smelled.
Forecasters and traders on Wall Street have been watching for months as interest rates on long-term US government bonds fell to near short-term debt rates.
Investors normally require higher yields to buy long-term bonds and, when these long-term yields decline, this may indicate a slowdown in economic growth.
On rare occasions, long-term yields may actually be lower than short-term bond yields – a "reversal of the yield curve" in the language of the markets. These unusual events preceded each recession in the last 60 years.
And it happened Friday.
The reversal follows a sharp decline in long-term Treasury bond yields this week after the US Federal Reserve decided on Wednesday to leave interest rates unchanged and said it was unlikely to increase its interest rates. rate by the end of 2019.
But a series of dubious economic data from Europe pushed the measure into reverse territory. The 10-year Treasury Note yield dropped to 2.45% Friday, its lowest level since January 2018. It was just below the 2.46% yield on three-month treasury bills.
There are many ways to measure the yield curve. On Wall Street, many analysts are looking at the difference between yields on two-year and ten-year Treasury notes., which has not yet reversed.
But a study by the US Federal Reserve in San Francisco has reported the difference in yield between three-month treasury bills and 10-year treasury bills – which reversed Friday – as the most reliable predictor of the risk of recession.
Stock market traders picked up the torch. The S & P 500 had risen despite the recent drop in bond yields, which helped prevent this downturn from being further evidence that the Fed would keep rates low for the foreseeable future. Keeping rates low has been a good thing for stocks over the last 10 years.
But on Friday, the S & P 500 index fell 1.9%, as stock market investors were increasingly concerned about economic growth prospects. It was the second worst drop for the market this year. The Nasdaq composite index fell 2.5%.
Experts in interpreting the predictive power of the yield curve have warned that a single day of a reversed yield curve does not necessarily mean that the economy would fall into recession.
Campbell Harvey, a professor of finance at Duke University, whose research first showed the predictive power of the yield curve in the mid-1980s, pointed out that an inversion would last on average three months before we could really say that the signal was clear. If this happens, history shows that the economy will fall into recession over the next nine to 18 months.
However, even with the history of the yield curve for predicting recessions, Professor Harvey pointed out that there is no certainty in economic forecasting.
"A model is only a model," he said. "It's not an oracle. This helps us to plan for the future, but it could fail at any time. "