Long-term Treasury rates added to their monthlong slide on Tuesday, aggravating a key yield curve inversion and sending the 10-year yield to its lowest level against the 2-year rate since 2007.
The yield on the benchmark 2-year Treasury note, more sensitive to changes in Federal Reserve policy, held steady at 1.533%, 4 basis points above the 10-year note’s rate of 1.493%. Earlier, the spread between the two yields dropped to 4.2 basis points, its most-negative point since May 2007.
The spread between the 3-month Treasury yield and that of the 10-year note — the Federal Reserve’s preferred inversion metric — slumped to -50 basis points, its lowest since March 2007. The 30-year bond yielded 1.978%, near its all-time low; the 30-year rate fell under 2% for the first time ever on Aug. 14.
Falls of the 10-year rate below the 2-year yield are viewed by fixed income traders as important recession prognosticators, marking an unusual phenomenon as bond holders receive better compensation in the short term. The Dow Jones Industrial Average retraced a 155-point gain on Tuesday as bond yields fell.
In fact, the 2-year rate has exceed that of the 10-year ahead of every recession over the past 50 years and the last five 2-10 inversions have all led to recessions. Timing any forthcoming recession, however, is tougher: even when an inversion does predict a recession, the yield curve inversion is, on average, 22 months early, according to Credit Suisse.
The worsening inversion is “certainly validating that a recession has a great chance of being here a year, year and a half from now,” said Kevin Giddis, head of fixed income capital markets at Raymond James.
Much of the market’s angst is a function of “what investors think the Fed’s going to do and the delay in the U.S.-China trade agreement,” he added.
Tepid inflation expectations and the Fed’s perceived inability to goose prices higher, Giddis said, offer a compelling reason to continue to buy 10-year and 30-year debt. The Fed tries to keep inflation around its 2% target, a pace it feel is both healthy and sustainable for the U.S. economy.
But despite historically low interest rates, price gains have remained tame.
Consumer prices as measured by the personal consumption expenditures (PCE) price index, the Fed’s favorite inflation gauge, edged up 0.1% in June as food and energy prices fell. In the 12 months through June, the PCE price index rose 1.4% after a similar increase in May.
The last inversion of this part of the yield curve was the one that began in December 2005, two years before the financial crisis and subsequent recession.
Though explanations for the market’s Tuesday moves were few, some pointed to comments by President Donald Trump following the Group of Seven (G-7) summit on Monday. The U.S. president said that China was sincere about a trade deal with the U.S., though his claim that Chinese representatives called top U.S. trade negotiators on Sunday night to resume talks has been disputed by Beijing.
Short-term yields were buoyed ahead of a string of auctions; the Treasury Department will sell $40 billion in 2-year Treasury notes, $41 billion in 5-year notes and $32 billion in 7-year notes.