Inverted Yield Curve Nears Its First Birthday—and There’s No Recession

The Treasury yield curve has been inverted for almost a year: The switch for the two-year and the 10-year Treasury came on July 11, 2022, when the two-year reached 3.07% and the 10-year 2.99%. As of Friday, the difference was 4.94% versus 3.86%. Since the 1950s, an inverted curve has meant one thing: A recession was on the way, but so far, not this time.

The economy has added four million jobs over the past year and unemployment is near a 50-year low. And judging by the stock market’s advance, with the S&P 500 up 16% this year and unemployment bumping along at a relatively low 3.7% rate in May, the odds of a recession in the near term are dwindling.

The New York Fed’s calculation of the probability of a hard landing by the end of 2023, which it defines as four quarters of economic performance slipping below 1%, has declined to 26%. That is down from its 70% reading last September. In the first quarter of this year, gross domestic product increased 2.0%, which of course is subject to revision.

A report by BlackRock Inc.’s Jeffrey Rosenberg, senior system manager, fixed income, put a lot of credence in the stock market’s optimism. “Recent market performance indicates that traditional forecast models may be overstating the timing of the arrival of any recession,” he wrote.

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All this has come despite the Federal Reserve’s aggressive rate-raising drive. And the central bank is not done yet. The Fed appears poised to increase its benchmark interest rate another half percentage point in the next few months.

When bond traders charge a lower rate on longer-term debt than on shorter-term paper, conventional wisdom holds that they think the Fed will have to cut rates as the economy declines.

Why has the inverted curve not delivered a recession, or at least the prospect of one soon? The Fed’s actions and huge economic stimulus from Washington altered the usual framework, according to Rob Haworth, senior investment strategy director at U.S. Bank, in a research note.

“Government support programs, along with monetary stimulus by the Fed, created unusual circumstances leading into the current yield curve inversion cycle,” Haworth wrote. Hence, GDP continues to grow, although at a slower pace.

The upshot, in his view: a recession may not be inevitable in the near term even with an inverted curve signaling otherwise.