By Karen Brettell
NEW YORK — A dramatic dip in Treasuries this week directed some key areas of the U.S. yield curve into reinvert, a signal that’s traditionally been bearish for the U.S. economy.
The curve involving two-year and five-year notes inverted on Monday for the first time since December, and also the three-month, 10-year curve turned negative on Tuesday for the first time since October.
As worries over the financial effect of China’s coronavirus led investors to search out safe-haven assets returns dropped.
The movement has offset optimism heading that inflation and growth would pick up, after the United States and China in December agreed to de-escalate their trade warfare.
The difference between three-month and 10-year returns is watched. An inversion, when yields fall under these on bills, has before been a reliable indicator that a downturn will follow in one to two years.
This region of the yield curve inverted for the first time since the 2007-2009 financial catastrophe.
While a recession could be prone to followalong with the timing is unclear, and fiscal policy could result.
Some analysts also feel that the relative appeal of U.S. bonds into those in Europe and Japan, many of which have negative yields, is maintaining longer-dated returns below where they would otherwise be, reducing the truth of the yield curve inversion as a recession signal.
WHAT IS THE TREASURY YIELD CURVE?
The yield curve is a plot of the returns all Treasury maturities — debt offered by the national government — ranging from 1-month invoices to 30-year bonds.
In normal circumstances, it’s an arcing, upward incline because bond investors expect to be compensated more for taking on the added probability of owning bonds with longer maturities.
The curve is also referred to as steep, when yields further out on the curve are substantially higher than those near the front. Therefore a bond will provide a higher yield than a 2-year note.
When the gap, or”spread”, is narrow, it is referred to as a horizontal curve. In that circumstance, a 10-year note, for example, may offer only a higher yield than a 3-year note.
What’s a CURVE INVERSION?
On rare occasions, a few or all the yield curve stops to be upward sloping. This happens when shorter-dated yields are higher than ones that are longer-dated and can be known as an inversion.
While various economic or market commentators may focus on different areas of the yield curve, any inversion of the yield curve tells the same story: An expectation of weaker growth in the future.
Back in March, inversion of the yield curve struck 3-month T-bills for the very first time in about 12 years once the yield on 10-year notes dropped below those for 3-month securities.
It has traded in positive territory since October, with the exception of Tuesday’s brief inversion.
The curve between 2-year and 10-year notes, that is also viewed as a recession indicator, inverted for the first time since 2007 at August. It has been positive since early September.
WHY DOES INVERSION MATTER?
Yield curve inversion is a classic signal of a looming recession.
The U.S. curve has inverted before each recession in the past 50 years. A signal was offered by it only once in that moment.
When short-term yields climb above longer-dated ones, it signals short-term borrowing prices are somewhat more costly than longer-term loan expenses.
Under these circumstances, companies often find it even more costly to fund their operations, and executives tend to temper or shelve investments.
The economy contracts and unemployment rises.
Shorter-dated securities are highly sensitive to interest rate coverage set by a central bank such as the U.S. Federal Reserve.
Longer-dated securities are more influenced by investors’ expectations for future inflation because inflation is anathema to bond holders.
Therefore, when the Fed is raising rates, as it did for three years, that pushes up returns on shorter-dated bonds in the front of the curve. And when future inflation is seen as contained, because it is now because higher borrowing costs are predicted to become a drag on the economy, investors are willing to accept relatively modest yields on long-dated bonds in the rear end of the curve.
(Reporting by Karen Brettell and Dan Burns; Editing by Megan Davies and Lisa Shumaker)