US yield curve: Invert, accentuate, repeat

(Reuters) – The rapid reversal of the US yield curve at 2 years / 10 years after its reversal last week may have given investors hope that the US will be able to exit the recession. They should probably take a breath.

The story indicates that the stay can be brief before a serious and prolonged reversal occurs.

A new reversal could occur later this week if the Federal Reserve's minutes at its July 30-31 meeting on Wednesday or Fed Chairman Jerome Powell's speech at the Jackson Hole Economic Conference on Friday, suggested that US policymakers would not agree with the decision. for an absolute rate reduction mode, which could raise rates in the short term and smooth the curve. For an explanatory on the yield curve:

Treasury yields at 2 and 10 years have reversed for the first time since 2007 last week, disturbing investors who saw it as a sign of imminent recession in the United States.

While the reversal over 2 and 10 years has disappeared for the moment, the previous three phases of reversal on this part of the yield curve have shown a tendency: a stiffening then a return to a more sustained inversion. or deeper more than once before a recession strikes.

The reversal between the three-month Treasury bill rate and the 10-year Treasury yield – which economists and some Fed economists see as a more reliable recession indicator – has been in place since May. This curve reversed in March, intensified in April, and reversed again.

While the stock market reacted with fear after the reversal, some feared that a recession would occur. The yield curve resumed its inversion and equities rebounded on Monday.

"We do not advise you to consider reversing the yield curve as a sure-fire predictor of an economic contraction or a bear market," said Mark Haefele, investment manager at UBS Global Wealth Management. .

At present, some investors have said that the latest episode of the reversal overestimated the chances of a recession. According to them, the Fed's openness to lower borrowing costs would prolong the current economic expansion, which has become the longest ever recorded last month.

"We do not consider the reversal of the yield curve as a sign of recession, and we see the central bank dovish pivot stretching the growth cycle," said Monday the BlackRock Investment Institute.

Here is how the curve worked in recent years after an initial inversion:

In February 2006, when the 2- to 10-year portion of the curve reversed, it lasted about a month before 10-year yields exceeded those of their two-year counterparts.

Then, the inversion reappeared about three months later and largely persisted until May 2007.

At the time, the US Federal Reserve was at the end of a rate hike campaign that finally raised the federal funds rate to 5.25% in June 2006, compared to 1.25% in June 2004.

"While moderating global demand growth is expected to help curb inflationary pressures over time, the Committee believes that there remain some inflation risks," Fed policy makers said in a statement. a press release at the end of their June 2006 meeting.

Some investors had downplayed the reversal, heralding an impending economic slowdown.

In mid-1998, the portion of the 2 to 10 year yield curve reversed briefly, then a more sustained reversal took place in 2000 as the stock market bubble exploded, plunging the economy into recession.

From December 1988 to May 1990, the yield curve reversed five times before a recession in June 1990.

In the late 1970s and early 1980s, inversion of the curves was a key pillar, as Fed Chairman Paul Volcker sought to fight double-digit inflation by tightening the money supply. which boosted the federal funds rate to more than 17% in 1980.