Treasury Yield Curve Dis-inversion Accelerates

Things are moving quickly in the financial space, and they are not moving in a desirable direction. Just last week I had written an article about the recent dis-inversion of the yield curve, and how this dis-inversion is a harbinger of economic recession.

There are two ways the yield curve can dis-invert. The “bear steepener” is bearish for bonds, but is good for stocks and the economy. The “bull steepener,” which is good for bond prices, is not good for the economy and probably not stocks either.

This dis-inversion is of the “bull steepener” variety signaling economic pain ahead especially if the curve continues to dis-invert until it takes a normal yield curve shape from short- through long-term rates.

As a visual reminder, here is what a “normal” yield curve looks like:

Source: https://home.treasury.gov/policy-issues/financing-the-government/interest-rate-statistics

This week has given us an acceleration in the yield curve dis-inversion which is unfortunately a very good sign that the wheels are quickly coming off the U.S. economy.

Here is an update to the yield curve as of August 2nd.

The blue line is the yield curve from April 25th of this year. The green line is the yield curve from July 24th which was displayed in my article. The orange line represents the yield curve from this past Friday, a mere 8 days from July 24th.

On April 25th, the 2-year note was yielding 4.96%, and the 10-year note was yielding 4.7% for a 26 basis point spread between these notes. On July 24th, interest rates had fallen with the 2-year yielding 4.37%, and the 10-year yielding 4.28% for a spread of 9 basis points.

As of August 2nd, the spread narrowed to 8 basis points with the 2-year note yielding 3.88%, and the 10-year yielding 3.8%. These are massive moves in the bond market.

For those who believe that the Federal Reserve controls interest rates, how do you explain an inverted yield curve, and how do you explain dropping rates if the Fed isn’t cutting?

We can clearly see that even short-term rates are beginning to fall, but the Fed hasn’t cut rates… yet.

If/when the yield on the 2-year note drops below that of the 10-year note, get ready for the Federal Reserve to begin cutting the Federal Funds Rate (FFR), and they will probably cut quite quickly. It won’t do any good because the Fed is not in control, they’re just along for the ride.

Perhaps you’re thinking, “Yea! Rates are dropping so now things will get cheaper!”

Understand that falling rates mean the economy is in trouble, and banks may not be willing to lend even though the cost to borrow is cheap, so you may not be able to benefit from lower rates.

But wait, it gets worse!

The latest employment report from the BLS was what you might call a disaster with only 114K jobs “created” with prior months once again revised down. But more to the point, the unemployment rate ticked up to 4.3% triggering the “Sahm Rule”

The Sahm Rule states that if the three-month moving average for the unemployment rate increases by half a percentage point over the low of the past year then a recession is likely already underway.

Out of the 11 recessions since 1950, the Sahm Rule has been an accurate indicator with two exceptions. The Sahm Rule called the recession early for 1959 and 1969, but ultimately recessions followed suit.

There are no guarantees that a recession will occur or that the stock market will get pummeled, but odds are certainly increasing for those very outcomes. Things also don’t move in straight lines so we could see some major bounces and falls in the stock and bond markets before a clear trend is established.

The captain has turned on the seat belt sign because the ride is about to get bumpy.