Inverted yield curve deepens over recession fears

The 2s-10s yield curve has been inverted for 9-months and is currently at -107 bps. The last time the yield curve was this far into inversion territory was in the early 1980s. An inverted yield curve often forewarns of an economic recession, as it suggests that investors expect short-term interest rates to fall, and normalise the curve. This can be a signal that the economy is headed for a downturn.

Yield curves invert when the yields on long-term bonds fall below the yields on short-term bonds of the same credit quality. It is when short-term interest rates are higher than long-term interest rates. Normally, the yield curve is upward sloping, so longer-term bonds have higher yields than shorter-term bonds. This is because investors demand a higher yield for tying up their money for a longer period.

However, when the yield curve inverts, it is a sign of economic trouble. This is because investors essentially signal that they are more concerned about the short-term economic outlook than the long-term outlook. Investors are demanding higher compensation for holding short-term bonds because of the perceived risk of economic instability sooner rather than later. In contrast, longer-term bonds are a more stable investment and investors will accept lower yields for greater security.

Also, the Fed is influencing short-term interest rates through their hawkish monetary policy. The inversion spiked down yesterday as Fed Chair Powell sounded more hawkish than anticipated in his testimony before the senate. The market fears that the probabilities of a hard landing have increased as the Fed looks to tighten further.

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Russell Shor

Senior Market Specialist

Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.

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