By Sunny Oh
The U.S. 2-year Treasury note yield /zigman2/quotes/211347045/realtime BX:TMUBMUSD02Y 0.00% traded above the 10-year note yield /zigman2/quotes/211347051/realtime BX:TMUBMUSD10Y 0.00% for the first time in over a decade early Wednesday, reinforcing recession worries.
The flattening of the main measure of the U.S. Treasury yield curve already spelled trouble for stock-market investors that have been on the back foot from escalating geopolitical concerns and simmering trade tensions, analysts at Bank of America Merrill Lynch said in a Tuesday note ahead of the inversion.
The inversion of the main measure of the yield curve, or a negative spread between short-term and long-term yields, means a recession indicator is flashing red.
“The equity market is on borrowed time after the yield curve inverts,” the BAML strategists wrote.
The yield on the 10-year Treasury note was down 5.7 basis points at 1.619%, according to FactSet, while the 2-year yield was off 4.1 basis points at 1.628%.
An inverted yield curve often serves as a prelude to a recession because it indicates when monetary policy and financial conditions are too tight for the broader economy. A yield curve inversion along the 2-year/10-year spread has come before the last seven recessions.
Still, the widely varying lag times between an inversion and an economic downturn makes it difficult to say if an inverted curve points to an imminent slowdown in growth.
Other yield curve measures have already inverted this year. Since May, the 3-month/10-year spread measure utilized by the New York Federal Reserve to analyze recession probabilities has been mostly stuck in negative territory.
But investors had previously pointed to the lack of an inversion on the 2-year/10-year spread as a sign that the bond-market was not pointing to a shuddering halt to economic growth. Rather, it suggested hopes that the Federal Reserve would secure a soft-landing for a U.S. economy through “insurance” interest rate cuts.
The renewed flattening of the curve could thus indicate that economic pessimism is gaining ground among bond traders, and that the Fed’s July rate cuts will prove the first of many as part of a full-blown monetary easing cycle.
Even if the 2-year/10-year spread inverts, equities do still have room to run higher — if only for a few months.
“After an initial post-inversion dip, the S&P 500 index can rally meaningfully prior to a bigger US recession related drawdown,” BAML strategists said.
When they crunched the numbers, they found that the S&P 500 tended to mount a last-gasp rally, peaking on average 7.3 months after an inversion along the 2-year/10-year spread.
Stock-index futures pointed to a lower start for Wall Street after a Tuesday rebound that lef the S&P 500 /zigman2/quotes/210599714/realtime SPX -1.05% around 3.4% below its all-time high.