The market’s favorite recession gauge is on its longest streak since 1980

Some bond market experts expected the curve to invert quickly after the Federal Reserve began delivering what could be four consecutive 75-basis-point rate hikes last spring.

It finally happened on April 1, 2022, but it didn’t last long, only until April 4. A few months later, in early July, the so-called “2s10s” curve inverted once more and remained in that position ever since. since.

Typically, bonds with longer maturities have higher yields because investors require compensation for the additional credit risk of lending money over a longer period of time.

However, when recession fears rise or the Fed raises interest rates aggressively, this relationship can be thrown out as investors are willing to accept a premium to keep their capital in longer-dated Treasuries. Bond yields move inversely to prices.

Few indicators have proven to be as reliable a warning sign of recession as the yield curve.

An inverted curve has preceded every U.S. recession since the early 1960s, said Campbell Harvey, a Duke University finance professor and head of research at Research Affiliates, an asset management firm.

Early in his academic career, Harvey began using the yield curve as a predictor of recession and found it to be an extremely reliable indicator. There have been no examples of yield curve inversions in recent history without a recession.

It is important to note a few caveats. In his research, Harvey chose to use the 3-month Treasury bill yield instead of the 2-year note yield, although economists, bond market strategists and traders use a number of different spreads. the preferred measure of the curve.

Another popular alternative is the yield spread between the 5-year Treasury and the 30-year bond.

The Duke professor and others argue that the 3-month/10-year spread is the most reliable of the yield curve indicators, even though it has only inverted since late October.

Right now, all the popular yield curve measures are flashing a recession warning in unison, Harvey told MarketWatch in a phone call.

“The yield curve shows that there is a strong possibility of a recession,” Harvey added.

He also noted that particularly deep inversion caused problems for the banking sector, contributing to the collapse of Silicon Valley Bank and other US lenders.

“Inversion is bad for banking, we’ve already seen it happen,” he said.

It turns out that the length of time the Treasury yield curve remains inverted is historically linked to the length of recessions that follow, with longer inversion periods typically preceding more severe downturns, according to data provided by Harvey.

At this point, it is difficult to say when the relationship between short-term and long-term bond yields may return to normal. According to Priya Misra, head of global interest rate strategy at TD Securities, investors need to be convinced of the defeat of inflation or that the US economy will overcome otherwise the historical link between inversion and recession.

“What the inversion does is the market is saying that growth is going to slow, but inflation is going to stay high,” Misra told MarketWatch in a phone call. “For the curve to steepen, inflation needs to be no longer an issue.”