Something weird happened in the bond market this week. The interest rate on the 3-year U.S. Treasury bond (2.35%) surpassed the rate of the longer-dated 10-year bond (2.34%).
In the finance world, we call this an inverted yield curve.
Usually, it’s the other way around, with longer-duration bonds yielding more than shorter-duration bonds. (We call this an upward sloping yield curve.) This is because it’s riskier for investors to tie up their money for an extended period of time, so they demand a higher interest rate to lend at longer durations.
But as our chart above shows, the difference between the 10-year Treasury rate and the 3-Treasury rate is now negative (orange line). That’s a sign that investors expect rates to come down in the long run due to lower economic growth and inflation.
That’s all fine and dandy, but here’s the kicker: every time the yield curve has inverted in the past 30+ years, an economic recession was right around the corner. (The shaded areas on the chart represent recessions, and as you can see, they tend to be preceded by the 10-year minus 3-year rate going negative.)
So that’s the concern today. The Fed is pushing up short-term rates, but longer-term rates aren’t budging to the same extent. In other words, the bond market expects growth and inflation to be lower in the long term.
The question is: will it be so much lower that it becomes an economic recession?
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