NEW YORK (AP) — One of the most closely watched predictors of a potential recession just yelped even louder.
The signal lies within the bond market, through which investors show how confident they are about the economy by their level of demand for U.S. government bonds.
It’s called the “yield curve,” and a significant part of it flipped Friday for the first time since before the Great Recession: A Treasury bill that matures in three months is yielding 2.46 percent — 0.03 percentage points more than the yield on a Treasury that matures in 10 years.
It seems illogical. Economists call it an “inverted” yield curve. Normally, short-term debt yields less than a long-term debt, which requires investors to tie up their money for a prolonged period. When a short-term debt pays more than a long-term debt, the yield curve has inverted.
And when the yield curve is inverted, it shows that investors are losing confidence in the economy’s prospects. Fear about the inverted yield curve contributed to Friday’s 1.9 percent tumble in the S&P 500 index — its worst day since Jan. 3.
This warning signal has a fairly accurate track record. A rule of thumb is that when the 10-month Treasury yield falls below the three-month yield, a recession may hit in about a year. Such an inversion has preceded each of the last seven recessions, according to the Federal Reserve Bank of Cleveland.
The last time a three-month Treasury yielded less than a 10-year Treasury was in late 2006 and early 2007, before the Great Recession made landfall in December 2007.
WHY DID THE YIELD CUVE INVERT?
Longer-term Treasury yields have been falling this year, in part on worries that economic growth is slowing around the world. When investors become nervous, they often abandon stocks and other risky assets and flock to Treasurys, which are among the world’s safest investments. High demand for bonds will, in turn, send yields falling. Accordingly, the yield on the 10-year Treasury has sunk to 2.43 percent from more than 3.20 percent late last year.
Shorter-term rates, by contrast, are influenced less by investors and more by the Federal Reserve, which raised its benchmark short-term rate seven times over the past two years. Those rate hikes had been forcing up the three-month yield, to 2.46 percent from 1.71 percent a year ago. This momentum will likely slow now that the Fed foresees no rate hikes in 2019. But if longer-term Treasury yields continue to weaken, the curve could remain inverted.