I’ve been camping for the last 10 days.  It was a really nice break, but back to business:

Treasury yields have now been inverted for the longest stretch on record, with the spread between the 2-year (US2Y) and 10-year Treasury (US10Y) underwater for close to two years. It’s got everyone worrying about a recession, though many of those calls have moderated in recent months as the U.S. economy continues by some reports to expand, and unemployment remains historically low.  Is this indicator, which has predicted every recession over the past 50 years, faulty or broken?

Some background: Yield curves typically slope upward, meaning that the longer you lend out your money, the greater of a return you would expect to receive.  So when short-term yields return more than longer-dated ones, it suggests there is reason to worry about the long-term economic outlook. It can also signal that the high levels of short-term yields are unlikely to be sustained as growth slows, which can have an impact on a range of asset prices. Investors usually factor in Fed rate cuts under those dynamics, with easing expectations signaling the potential for a faltering economy.  The chance of a rate cut this Wednesday are at 0.6%, with a 8.8% shot in July, and a 49% possibility in September.  At this point, we don’t see a statistically sound probability until November 7th,  which is two days after the presidential election.

The quirky thing about this tried and true indicator is that it just predicts that an inflation will happen, but the causation is always something completely different. Covid, housing market collapsing, dot com bubble bursting, savings and loan crisis, oil prices, and oil embargo brought on the last six recessions.  Mark my words, the next one is coming.  And when it does, it will bring with it lower interest rates.