Over the past two years, there has been concern in the financial markets as the 2-year US Treasury yield has consistently traded above the 10-year yield, which historically indicates a looming recession. However, last week, there was a shift as the 2-year yield fell below the 10-year yield, resulting in an “uninverted” yield curve. This change was driven by factors such as the jobs report showing a slight decrease in the unemployment rate, leading to expectations of lower interest rates and subsequent Fed rate cuts.
The inverted yield curve, where the 2-year yield is higher than the 10-year yield, usually signals that investors view the near-term future as riskier than the long-term future. In contrast, a positive or uninverted yield curve is considered a more normal market scenario. Despite the current uninversion, there are concerns that previous instances of a positive yield curve shortly preceding Fed rate cuts have often been followed by recessions, as seen in past economic downturns like the dot-com crash and the Great Recession.
While the uninversion of the yield curve is seen as a potential indicator of future economic activity, experts like Marco Giacoletti and Kristina Hooper caution against solely relying on this signal. Hooper notes that the recent prolonged period of yield curve inversion may indicate that any recession signaled by the current uninversion may be further out than historical patterns suggest. Factors like government debt issuance and labor market indicators, such as the Sahm rule which predicts recessions based on unemployment rate increases, are also being monitored.
Kevin Flanagan emphasizes the importance of looking at labor market indicators to gauge the state of the economy, rather than solely relying on the yield curve. While the unemployment rate has risen, it has not reached levels that typically signal an imminent recession according to the Sahm rule. Flanagan finds optimism in the four-week moving average of initial jobless claims, which are currently lower than levels seen before prior recessions, except for during the pandemic. This trend suggests a more stable labor market despite some cooling.
Despite concerns over the potential for a recession following the uninversion of the yield curve, experts like Kristina Hooper and Kevin Flanagan remain cautiously optimistic about the economy’s outlook. They highlight the complexity of factors driving yield movements and the potential for the current economic situation to differ from historical patterns. While the uninversion of the yield curve is a noteworthy signal, it is just one of many indicators that economists consider when assessing future economic activity. Ultimately, the future state of the economy will depend on a combination of factors, including Federal Reserve actions, government spending, and labor market trends.
