Macroscope | The bond market flashes a ‘recession warning’, but it’s not time yet to panic

An inverted yield curve typically precedes a worsening economic outlook, even a recession. But this time, as yield on 10-year Treasuries dipped below that on the three-month bills, many other factors were at play. There’s no guarantee a recession will follow

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The Federal Reserve Board, whose building is seen here on Constitution Avenue in Washington, suggested that the unprecedented wave of quantitative easing undertaken by central banks around the world may have contributed to the flatter yield curve for Treasury bills. Photo: Reuters

Published: 12:35pm, 31 May 2019Updated: 10:20pm, 31 May 2019

The bond market has started to flash what could be a warning sign as interest rates on longer-term United States government bonds – also known as Treasury bills – fall below those on short-dated bonds. This phenomenon is known as a yield curve inversion, and often signals a worsening economic outlook in the medium term, or even a recession.

Investors often compare the interest rates, or yields, on shorter-dated Treasury bills – such as those maturing in three months or two years – with those on longer-dated bonds maturing in, say, a decade, as this spread can offer important information on what to expect in the near term versus the long term.

An inverted yield curve certainly contains important information, but the movements of Treasury bills this week may not necessarily be harbingers of doom. It matters a great deal which part of the curve is inverted.

On May 23, the spread between the yields on three-month and 10-year Treasuries turned negative. However, the spread between the two-year and 10-year Treasuries has not – and it is this spread that is most commonly referenced when watching for a yield curve inversion.

Still, it is worth noting that the spread between two-year and 10-year Treasuries remained in the 14 to 18 basis points range, where one basis point refers to 0.01 of a percentage point. At this range, the spread is hovering near its lowest levels since the global financial crisis and the last US recession. In the lead-up to prior recessions, this spread has often gone into inversion before or concurrently with an inversion in the spread between the aforementioned three-month and 10-year Treasuries.