Recession looming?

You may have heard lately that the two and ten-year yield curves have inverted and that it’s an indication a recession is coming. What it means in short is that the bond market isn’t buying the idea that the Fed is going to be able to engineer a soft landing of the economy as it raises rates. It’s looking like the best-case scenario now is that the Fed can potentially manage one of its goals, price control or positive economic growth, but not both.

The short end of the yield curve is generally a reflection of short-term Fed interest rate policy decisions. As the Fed raises rates or is expected to do so soon, short-term rates tend to rise. The most used rate on the curve to measure this is the 2-year yield.

The long end of the yield curve is reflective of two things, expectations of longer-term Fed interest rate policy and future growth. It is measured by movements in the 10-year yield. If the Fed chooses to raise interest rates and the market expects positive economic growth to continue, long-term yields can generally remain higher than short-term yields. When the markets expect that the growth cycle has matured and a slowdown could occur, the long end of the curve can fall in anticipation of the idea that the Fed may begin cutting rates to reinvigorate growth.

The inversion of the yield curve doesn’t necessarily mean that a recession is around the corner and the general guideline is that an official recession begins somewhere around 12-24 months following an inversion of the curve. Risk of a recession over the next year or so still seems low. The US economy is holding up well, posting record low unemployment rates and still in the process of opening as can be seen by the increases in air travel and other leisure activities. The most likely outcome remains that a recession officially begins in the next 18-24 months, but there are still a lot of moving parts at play.