U.S. Bond Market Signals Possible Recession as Treasury Yield Curve Approaches Positive Territory

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Treasury Yield Curve Shows Signs of Change

The U.S. bond market neared a significant turning point, with a closely monitored indicator on the Treasury yield curve edging closer to positive territory for the first time since 2022. According to Dow Jones Market Data, the yield on the 2-year Treasury note, which stood at 3.774%, has been higher than its 10-year counterpart, which was at 3.769%, for a record 544 trading days.

Historically, such inversions—where shorter-term yields exceed longer-term yields—the U.S. bond market signals possible recession. However, it is the transition back to positive territory after an inversion that often raises concerns about the health of the U.S. economy and the stock market. As noted by MarketWatch’s Joseph Adinolfi last month, this shift can signal potential economic trouble.

Narrowing Yield Gap

On Wednesday, the yield on the 2-year Treasury note nearly fell below the 10-year rate, marking a potential end to the inversion. By the afternoon, the two yields were almost identical, with both at 3.78%, as reported by FactSet. For the inversion to be officially reversed, the 10-year yield must close above the 2-year yield.

The last time the spread between these two yields was positive was July 1, 2022. This data, provided by Dow Jones Market Data, uses closing figures from 3 p.m. Eastern Time and dates back to 1977. Investors last observed similar yield curve movements in October 2019, just before the onset of the COVID-19 pandemic and the subsequent brief recession.

Economic Outlook

Despite the shifting yields, there are indications that a recession might still be avoided, even if economic growth appears to be slowing. Guy LeBas, chief fixed income strategist at Janney Montgomery Scott, noted that there is no concrete evidence of an imminent recession. He observed that traders are pricing in about 10 rate cuts in the current cycle, a figure he considers aggressive. Historically, the Federal Reserve has typically implemented three rate cuts over three quarters during soft landing scenarios. Ten cuts would suggest more severe economic conditions.

The years of ultralow interest rates may be influencing the effectiveness of traditional recession indicators.

Stock Market Implications

Looking ahead, the performance of stocks following past un-inversions of the Treasury yield curve has been mixed. Over the past 40 years, the S&P 500 index, on average, increased by 2.6% three months after the yield curve turned positive for at least 50 trading days. However, past instances also show significant declines; for example, after the yield curve turned positive in 2000, the stock market dropped 11% in the following three months and fell by 12.9% a year later, according to Dow Jones Market Data.

LeBas also anticipates that Friday’s monthly jobs report will provide further insight into the economy’s strength, particularly as September begins with market uncertainty. Additionally, he pointed out that recent heavy corporate bond issuance might be affecting equity markets by drawing capital away.

As the Treasury yield curve approaches a potential shift, market participants remain watchful of economic signals and their possible implications for both the economy and stock markets.

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