Shifting U.S. bond yields leave investors guessing about the economic outlook

Stay up to date with free updates

Simply register at US interest rates myFT Digest — delivered straight to your inbox.

Short-term US government borrowing costs have fallen below long-term costs in a reversal of the so-called “inverted yield curve”, a move that some analysts believe could herald an impending economic recession.

The yield on the rate-sensitive two-year Treasury fell below its 10-year counterpart on Thursday after data showed the U.S. private sector added the fewest jobs in three and a half years in August. Bond yields move inversely to prices.

An inverted yield curve—when long-term yields are lower than short-term yields—has historically been seen by some investors as an indicator of a recession, though it hasn’t always proven accurate. The bond market has sent this signal almost continuously over the past two years.

However, investors and strategists are divided on what the end of this reversal could mean – driven by investors increasing their bets on rapid interest rate cuts in recent weeks. While some speculate that it could mean better news about the economy, others say it may mean the exact opposite – that a recession is now imminent.

“It’s tempting to suggest we can call it safe” on the economy, but “we’re not out of the woods yet,” said Jim Reid, Deutsche Bank strategist. He said recessions tend to start when the yield curve moves away from being inverted.

“Indeed, the last four recessions only started once the curve turned positive again,” he said.

However, James Reilly, an economist at Capital Economics, said that while spread disinvestment “has tended to precede recessions in the past . . . this move in yields is more a symptom of investor concerns than a new cause for alarm.”

“The Treasury yield curve has flattened in recent weeks amid growing recession concerns, but we doubt that will materialize this time,” he said.

Short-term yields are historically typically below long-term yields, reflecting the higher risks of lending over longer periods of time. When short-term borrowing costs more than long-term borrowing, it means investors expect growth – and therefore interest rates – to be lower in the coming years.

Swaps markets fully expect a quarter-point interest rate cut from their current range of 5.25 to 5.5% at the Fed meeting later this month, and are also valuing a chance of 40% half point discount. They expect just over a percentage point of cuts by the end of December.

Labor market data on Wednesday showed U.S. job openings were lower than expected for July, triggering the latest sharp rise in short-term government bonds.

Figures on job openings and labor turnover showed that U.S. job openings fell to 7.7 million in July, the lowest level in three years and less than economists had expected.

The two-year Treasury yield briefly dipped below the 10-year yield on Wednesday before holding in a tight range just above the “inversion” threshold as investors expected the numbers to keep the Fed on a dovish path installments this month. .

“At the edge, JOLT data matters,” said Ajay Rajadhyaksha, global head of research at Barclays. “(The Fed) takes it seriously; they will not shrug. The market knows that and that’s why you got that short deactivation.”

This is “not so much about the yield curve,” he added, “but the front-end rally in anticipation of a faster cut cycle.”

Cementing investor expectations for looser monetary policy, Fed Chairman Jay Powell signaled at the Jackson Hole economic conference in August that “the time has come” for US interest rate cuts. He told the symposium that “downside risks” to the labor market have increased.

The yield curve already briefly inverted early last month after a much weaker-than-expected July payrolls report stoked fears of a looming recession and prompted investors to bet on quick and deep cuts of the interest rate.

Those concerns were later eased by a series of stronger economic reports, but market participants are watching each data point closely for clues about the future path of US borrowing costs.

Friday will bring the latest non-farm payrolls report, with economists expecting US employers to have added 160,000 jobs in August, according to a Reuters poll – considerably higher than the previous month’s figure of 114,000.

“We think the front end might have gone up a little too far,” added Skiba. “We’ve struggled to see the Fed cutting more than (a percentage point) here in the absence of worsening economic data — but clearly that’s the debate from a market perspective at this stage.”

Additional reporting by Ray Douglas