Dollar weak as U.S. Treasury yield curve inversion sparks recession fears

A trader works on the floor at the New York Stock Exchange in New York City US Dec. 4

A trader works on the floor at the New York Stock Exchange in New York City US Dec. 4

And, even if the latest kink in the yield curve is indeed the first signal of a downturn as many suspect, it does not indicate when it will actually begin nor how severe it will be. In other words, bond holders were okay with being paid less to tie up their money longer with the USA government.

The yield curve is a plot of the yields of bonds with equal credit quality but different maturity dates.

"The yield curve has sent a chill down investors' spines in regard to the future outlook of the USA economy", said Chad Morganlander, senior portfolio manager at Washington Crossing Advisors in New Jersey. When the economy is healthy and investors are forecasting good times ahead, they generally demand higher yields for Treasurys that mature a decade or more into the future than those maturing in a year or two.

After months in which concern about the yield curve had eased, its sudden narrowing on December 3 could disrupt what had seemed a strong consensus at the Fed to continue raising rates through 2019.

Whatever the reason, investors and economists ignore this message from the bond market at their peril: yield curve inversions - when shorter-dated securities yield more than longer maturities - have preceded every US recession in recent memory by anywhere from 15 months to around two years.

The last time that happened before this week?

Short-term rates traditionally move in tandem with changes in the Federal Reserve's overnight lending rate, the Federal funds rate.

On Tuesday the yield curve signaled caution and, along with worries about global trade and interest rates, it helped send the stock market to one of its worst days of the year. For its part, the central banks says that pushing up rates is necessary to keep the economy from overheating.

While some regional bank presidents have been explicit in arguing the Fed should hold off raising rates to avoid an inversion, the consensus has been consistent: stay the course. This may, in turn, lead to lay-offs and a slowdown in employment and growth and ultimately force the Fed to cut rates to spur the economy. And when is that fuel needed?

When did the yield curve invert?

On Monday, the yield on the five-year Treasury note slipped below yields on shorter-dated three-year notes, according to a report in Bloomberg.

Is it happening to all bonds?

The more closely watched part of the curve-the gap between two-year and 10-year yields-remains upwardly sloped.

Let's take a look at how we got here.

So should I brace for a recession?

This inversion of the yield curve spooked investors Tuesday with a bloodbath taking place across financial markets.

"In the initial phase of the inversion of the yield curve markets are anxious and react more aggressively to weak data than to strong data", said Masafumi Yamamoto, chief currency strategist at Mizuho Securities. The job market is strong, and consumer confidence is still high.

"Current rates of consumption, investment and employment growth in the major developed markets are not historically consistent with an impending recession", UBS analysts wrote in a research note this week. Asked about the possibility of an inversion at a June press conference, Powell said "what we really care about is what's the appropriate stance of policy".

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