- The yield curve disinverted this week, suggesting an economic recession may be near.
- Historically, yield curve disinversions have preceded every economic recession since 1976.
- Investors are reacting by selling stocks, with the Nasdaq 100 dropping 2.6% on Friday.
A recession may be at hand based on an indicator that began flashing this week.
The inversion of the yield curve, which occurs when short-term bonds offer a higher yield than long-term bonds, is over for now after a more than two-year-long stretch.
The 10-year US Treasury yield was about 3.70% Friday afternoon, while the 2-year US Treasury yield was 3.66%. Several times this week, the yield curve has flipped between positive and negative territory.
The yield curve’s positive interest rate spread represents its first disinversion since September 2019 and the first time the yield curve was positive since July 1, 2022, according to data from YCharts.
According to Interactive Brokers’ senior economist José Torres, investors should pay close attention to the disinversion of the yield curve because of its long-term track record of predicting recessions.
“A positive spread across the 2- and 10-year Treasury maturities following a long period of a negative difference has historically preceded economic downturns,” Torres said in a note on Friday.
Since 1976, every single economic recession has been preceded by a disinversion of the yield curve.
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The ultimate question for investors is whether the current yield curve disinversion will be sustained or if interest rate volatility picks up and the spread between short-term and long-term bonds goes back into negative territory.
Either way, investors are selling first and asking questions later, as evidenced by the sharp decline in stock prices on Friday, with the Nasdaq 100 down about 2.6%.
“Investors are responding by unloading almost everything,” Torres said, adding that the August jobs report unlocked the “painful” disinversion.
The August employment report showed employers added 142,000 jobs, which was below economist estimates of 164,000. The reading sparked fresh concerns of a continued slowdown in the broader economy.
Yet, economist James Reilly at Capital Economics isn’t so sure the disinverted yield curve will prove to be the same canary in the coal mine it’s been historically.
That’s because various measures of risk premia across markets are not ringing alarm bells today like they were one month ago when the yen carry trade unwind sparked a sharp decline in the stock market.
“On balance, investors seem to think that disinversion will not be followed by a recession. That is to say, they think this time will be different. That’s always dangerous, of course – but we are of the same view,” Reilly said in a Thursday note.
He added: “Still, the signal can’t be ignored entirely.”
This isn’t the first recession warning to go off in recent weeks. The Sahm Rule flashed last month following the July jobs report, and there’s a slew of other recession gauges that have investors worried this year.