Growing Yield Curve Inversion Raises Concerns Of Ignored Recession Warning in Stock Market

On Wednesday (June 28), the U.S. Treasury yield curve inverted further, with the yield on the two-year note exceeding the yield on the 10-year note by a full percentage point.

This is the biggest level of inversion since March 9, when a slew of regional bank failures disrupted the Treasury yield curve. 

The inverted Treasury yield curve holds an important significance as it has historically predicted each U.S. economic recession since 1970, despite some lag between the inversion formation and the onset of a recession.

Chart: Treasury Yield Curve Inversion Heading To A Retest of 2023’s Extremes

Yield-Curve-Implied U.S. Recession Probability Is 71%

New York Federal Reserve’s recession probability model, which bases its projections on the inversion of the yield curve between 3-month and 10-year Treasury yields, now predicts a 71% chance of a recession occurring during the next 12 months.

This is the highest probability in more than 40 years, indicating that the bond market is seriously contemplating a recession.

Since July 2023, nearly a year ago, the U.S. Treasury yield curve has been inverted continuously.

But in the post-war (World War II) era, wide yield curve inversions of more than one percentage point were uncommon. Notably, dramatic yield curve inversions were frequently seen between the fourth quarter of 1979 and the third quarter of 1981. During that time, then-Federal Reserve Chairman Paul Volcker significantly responded to a double-digit inflation by increasing the fed funds rates to a record-high level of 20%.

Also Read: Taking Powell At His Word: Wall Street Analysts Foresee Further Rate Hikes, US GDP Growth

Stocks Turn The Head Away

The bond market’s warning signs of a recession haven’t shaken investor confidence in the stock market.

The Nasdaq 100 index, as tracked by the Invesco QQQ Trust Series 1 QQQ, rose a staggering 35% so far this year, putting it on track for its best first half ever.

The S&P 500, tracked by the SPDR S&P 500 ETF Trust SPY, also entered a bull market after gaining more than 20% from its October 2022 lows. More than two-thirds of S&P 500 stocks are trading higher than their 50-day moving averages, a positive sign that runs counter to predictions of an economic slowdown.

There appears to be a sizable disconnect between how investors in bonds and stocks view the economy’s future.

In his most recent speech at the European Central Bank’s forum on Central Banking, Fed Chair Jerome Powell noted that, while a recession is not in his base case scenario, it is nonetheless a possibility that can be triggered by the impacts of monetary tightening.

Now Read: Powell Leads Global Central Bankers’ Consensus On Inflation: More Rate Hikes Needed