The classic recession warning signal is flashing in the US Treasury market - the 10-year US Treasury yield is lower than the 3-month US Treasury yield, the so-called yield curve inversion. Over the past few decades, this warning signal has a reliable record of predicting recessions (12-18 months after the signal appears).
In fact, the New York Fed considers it a so reliable indicator that it updates this relationship every month and provides the probability of a recession in the next 12 months. At the end of January, when the 10-year US Treasury yield was about 0.31 percentage points higher than the 3-month US Treasury yield, the New York Fed's model showed that the probability of a US recession in the next 12 months was only 23%. However, with the inversion of the 10-year US Treasury yield and the 3-month US Treasury yield, the probability of a recession has risen.
"If investors are taking a more risk-averse stance out of fear of growth, that's to be expected. This often happens late in the business cycle," said Joseph Brusuelas, chief economist at RSM. "It's not clear if this is more noise or a signal that we're going to see a more significant slowdown in economic activity."
While the market pays closer attention to the relationship between the 10-year Treasury yield and the 2-year Treasury yield, the Fed prefers the difference between the 10-year Treasury yield and the 3-month Treasury yield as a measure because the 3-month Treasury yield is more sensitive to changes in the federal funds rate.
However, the 10-year-3-month Treasury yield curve inversion has a reliable but imperfect history of prediction. In fact, the last time this yield curve inverted was in October 2022, and the U.S. economy still did not enter a recession two and a half years later. Therefore, the latest yield inversion does not necessarily mean that a recession is sure to happen. But investors are worried that the growth expectations brought about by U.S. President Trump's ambitious economic agenda may not be realized.
After the presidential election on November 5, 2024, the 10-year Treasury yield began to soar. This is usually a clear sign that investors expect the economy to grow further. However, some market professionals pointed out that this also shows investors' concerns about inflation and their demand for higher yields on government bonds amid the growing debt and deficit problems in the United States.
Since Trump took office, the 10-year Treasury yield has fallen sharply, falling by about 32 basis points so far. The reason is that investors are worried that Trump's tariff-focused trade agenda will push up inflation and slow economic growth.
In addition to the warning signal of the inverted 10-year-3-month Treasury yield curve, a series of data released recently also showed signs of slowing economic growth. Data released on Tuesday showed that the US Conference Board Consumer Confidence Index in February plummeted to 98.3, the largest drop since August 2021, far below the economists' forecast of 102.5, and even lower than the most pessimistic forecast of 99.3.
Among them, the US Conference Board Consumer Expectations Index in February plummeted from 82.2 to 72.9. The expectation index falling below 80 is usually seen as a sign of recession. This is the first time since June 2024 that the expectation index has fallen below 80, the warning line for economic recession, and it has hit the largest monthly decline since August 2021. Before the 2008 financial crisis, the expectation index continued to decline, warning of consumption contraction and economic recession risks in advance.
At the same time, data released last Friday showed that the University of Michigan's 1-year inflation rate expectations rose to 4.3% (3.3% higher than the previous value), and the University of Michigan's 5-year inflation rate expectations in February finally rose to 3.5% (3.2% higher than the previous value), the highest level since 1995.
On the one hand, there are concerns about economic recession, and on the other hand, there are concerns about high inflation. This combination can be called "economic poison" - the coexistence of recession warnings and rising inflation directly shakes the narrative foundation of "the perfect interest rate cut by the Fed".
However, some other indicators, including consumption and the labor market, still show the resilience of the US economy. In this regard, Tom Porcelli, chief U.S. analyst at PGIM Fixed Income, said: "We are not expecting a recession, but we do expect economic activity to be weaker in the coming year."
The market has also begun to agree with the view that U.S. economic activity will weaken. Traders this week resumed betting that the Federal Reserve will cut interest rates twice this year and once next year to around 3.65%, which means that traders believe that as economic growth slows, the Federal Reserve will ease monetary policy to support the economy.
FWDBONDS Chief Economist Chris Rupkey said that the bond market smells "the smell of recession in the air." But Chris Rupkey is not sure whether a recession will actually happen because the labor market has not shown signs of an impending recession. He said that the inverted yield curve "is purely because the economy is not as strong as people thought when the Trump administration came to power." "I don't know if we are predicting a full-scale recession, and a recession requires unemployment numbers (to prove)."
