Watching the Curve

Don't confuse stocks' calm day with sudden optimism about the economy. In fact, the bond market looks increasingly certain that a recession is on the way. My colleague Lawrence Strauss notes today that "the U.S. Treasury yield curve "recently inverted to a point that hadn’t occurred since the early 1980s, signaling that a recession is on the way."

Yields on short-dated debt are usually lower than those on securities maturing over longer periods because investors demand higher yields to cover the risk of holding the debt for longer. But on Tuesday morning, the 2-year Treasury's yield was 4.46%, compared with 3.70% for the 10-year note, a spread of about 76 basis points, or 0.76 percentage point.

On Friday, the gap was 77.8 basis points, the biggest differential since Oct. 5, 1981, according to Dow Jones Market Data. That was when interest rates were in double digits as the Fed sought to fight the stagflation of the 1970s, triggering a recession in the process. The inversion back then was 79.4 basis points.

Yield inversions aren't perfect predictors of a recession, but when long-term lending rates fall below short-term ones, it's usually a sign that the economy is due for a contraction. 

Read the rest of Lawrence's story here.