Since July 2022, the yield curve has been inverted, with short-term Treasury bonds yielding more than longer-term ones. But by Wall Street pros’ projections, this abnormal pattern will end … by December 2024.
If their forecast comes true and the economy avoids an economic downturn, then the inverted curve’s longstanding role as a recession harbinger is kaput, at least for the moment.
One big factor: The Federal Reserve has indicated, via its “dot plots” of policymaker estimates for the future, that the body will cut its federal funds rate benchmark this year. That is certain to affect short-term rates the most, as long-term rates are more closely aligned with macroeconomic forces such as economic growth and global demand.
Lately, the spread between the two-year Treasury and the 10-year—the standard measure of the curve’s shape—narrowed, as of Tuesday, to 26 basis points, from 152 bps six months ago.
Thus, the inverted curve should right itself by year-end, according to a Reuters poll of 62 bond strategists. The survey contended that the Fed’s actions will lead to the two-year note sliding to 3.5% annually from 4.37% (dropping 87 bps), but the 10-year would descend less steeply, to 3.75% from 4.11% (falling just 36 bps).
In other words, the longer maturity would at long last out-yield the shorter one, by 25 bps. The curve would then revert to its customary upward-sloping direction.
Of course, much can go awry over the full span of 2024, even though current conventional wisdom holds that no recession will occur this year. The thinking was the opposite 12 months ago, with many predicting a 2023 slump.
“In a window of six to nine months [from now], there could be a recession,” says Nick Mastroianni, a fixed-income portfolio manager at Western Asset Management Co., who was not part of the Reuters survey but is familiar with it. Still, he added, the economy “is resilient enough to avoid a recession in 2024.”
Along with that conclusion, it is also logical to anticipate that “the curve will dis-invert by the end of the year,” he says. In terms of yield changes, he notes that expectations for Fed policy easing have been “priced in since the beginning of November.”
What about the issue of the inverted curve’s waning predictive power? A Y Charts analysis points out that inversions had preceded six previous recessions since 1976 (with the last one being 2020’s pandemic downturn), each time in less than two years from the inversion’s start to the downturn..
Currently, the relation between an inversion and a recession may have been trashed, in the eyes of Campbell Harvey, a professor of finance at the Fuqua School of Business at Duke University. He ought to know: Harvey discovered the inversion-recession pairing in his 1986 doctoral thesis.
Speaking on the “Forward Guidance” podcast on January 16, Harvey pointed out that near-zero interest rates and the pandemic may have severed the link. The result has been “the most talked-about potential recession in history,” he said, one that has not hit.
The present inverted curve, he said, “may be a false signal.” The months ahead will show if that is true.
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Tags: Campbell Harvey, Federal Reserve, Interest Rates, Inverted Yield Curve, Nick Mastroianni, Recession, Reuters, Two-year Treasury