After the yield inversion of US Treasury bonds reached its most severe level in nearly half a century in mid-2023, it is now almost completely resolved. However, looking back at history, every time this situation occurs, an economic recession follows shortly after. Is it calm before the storm now?
(Previous summary:
US Treasury yield plunges to 4.13%, “bottom fishing” brings huge profits, will the Federal Reserve cut interest rates in 2024?)
(Supplementary background:
Why hasn’t the US economy entered a recession? Wall Street Journal: These three reasons have avoided a hard landing…)
Table of Contents:
Economic recession has occurred after the resolution of yield inversion for nearly half a century
What is the yield of US Treasury bonds?
What is yield inversion?
Economists often say that there is a high probability of an economic recession after the yield curve of US Treasury bonds inverts. Currently, according to WGB data, the 2-year Treasury bond rate in the US is 4.34% and the 10-year rate is 4.13%. Compared to the severe inversion phenomenon that was nearly 100 basis points in early 2023, the inversion has almost been resolved (long-term bond yields higher than short-term bond yields).
However, for the seemingly soft landing US, this may not be a good sign, as every time the yield inversion is resolved in the past half century, an economic recession follows. Can the US escape this time?
Further reading:
Fed dove predicts two interest rate cuts in 2024, actions will be seen in the third quarter
(Source: WGB US Treasury bond yield overview)
From the historical data chart of “Finance M Square” below, we can see that the US has experienced a total of five economic recessions from the 1980s to the present, and yield inversion has occurred before each of them. Please see the following summary.
1981-1982:
The second oil crisis caused inflation to rise again, and the US central bank implemented strong monetary tightening, leading to another recession.
1990-1991:
Monetary policy tightened, coupled with the supply shock caused by the Gulf War, pushing inflation higher again.
2001:
The dot-com bubble burst, coupled with the impact of the 9/11 attacks.
2008-2009:
The US real estate credit crisis and financial crisis erupted.
2020:
The global lockdown caused by the spread of the COVID-19 pandemic.
Except for the COVID-19 pandemic in 2020, the previous four economic recessions coincidentally occurred after the resolution of yield inversion. If history repeats itself, investors who expected stable growth in the US economy may need to “fasten their seat belts” because stock market, CPI, unemployment rate, and other data are all considered lagging indicators of the economy.
Further reading:
Wall Street Journal: 60% of economists believe that the “rate hike cycle has ended” and the US will avoid an economic recession.
(Source: WGB US Treasury bond yield overview)
As the world’s largest economy, the US is generally considered to have a low risk of default on its issued bonds, making them popular among investors. The so-called “US Treasury bond yield” simply refers to the return on investment of this investment.
Usually, when the US issues bonds, there are “face value” and “coupon interest”. The bond yield = “coupon interest / face value * 100%”. Since the coupon interest does not change but the face value fluctuates with market demand, the yield will vary.
For example, let’s say you invest in a US bond with a face value of $1,000 and receive $30 of coupon interest income after one year. The annualized return on investment is 3%, which is the yield.
However, when the demand for bonds decreases, investors can buy them at a lower price, such as $800. In this case, with the interest rate unchanged, the yield becomes 30/800 * 100% = 3.75%.
The yield curve, also known as the yield curve, is a chart composed of the yield of bonds with different maturity dates. Normally, bonds with longer terms require a longer time to recover the principal and are exposed to more risks (such as inflation and war), so the yield is usually higher.
But as the risk of an expected economic recession increases, investors gradually reduce their holdings of risky assets such as stocks and increase their holdings of long-term bonds (causing the face value to rise) and other hedging products, causing long-term bond yields to decline. This leads to a “yield inversion” where short-term bond yields are higher than long-term bond yields.
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