Yield curve inverts for first time in a decade

Yield curve inverts for first time in a decade

Meanwhile, the flattening US yield curve weighed on investors' minds. Sometimes, yield curves can become inverted, a scenario in which short-term yields are higher than long-term yields.

What is a yield curve?

In other words, bond holders were okay with being paid less to tie up their money longer with the USA government.

"The focus is now shifting to the inverted US bond yield curve, which has negative connotations, while implying the USA economy is heading towards what was, only a few weeks ago, an improbable economic slowdown", said Stephen Innes, head of trading for APAC at Oanda.

Whatever the situation with the Fed and the USA markets, emerging markets may be effected even more than the US economy.

Such an inversion of two-year and 10-year yields, when 10-year bonds yield less than their two-year debt, has preceded every USA recession in the past 50 years.

In fact, one section of the yield curve has already inverted: between 3-year and 5-year notes. Economist Will Denyer of Gavekal Research notes that the yield curve has flattened, and eventually inverted, before every US recession since the mid-1950s (see chart below). Try 2007 - shortly before the housing crash put the economy in a hole Americans are still climbing out of.

Should this harbinger of bad news hold, the US economy is nearly certainly looking at a slowdown if not an outright recession.

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Dallas Federal Reserve bank president Robert Kaplan said the Fed was now in a "more challenging" period as global growth slows and parts of the American economy begin feeling the impact of Fed interest rate increases. Powell in remarks last week reiterated his upbeat outlook of an economy growing above potential, with the unemployment rate the lowest in almost 50 years, and in no need of emergency level interest rates. For its part, the central banks says that pushing up rates is necessary to keep the economy from overheating. Rate hike probabilities provide the proof. This may, in turn, lead to lay-offs and a slowdown in employment and growth and ultimately force the Fed to cut rates to spur the economy. And when is that fuel needed?

"The curve has to invert and it's going to happen sooner than people think". On Monday of this week, the USA government's five-year bond yielded less interest than the three-year bond. And that's why investors are paying attention to this latest hiccup in bond yields.

However, investors are increasingly concerned by a flattening of the spread between 2-and 10-year Treasuries, a more fundamental benchmark of market health.

"It could be many months before we see that point of the curve invert", he said in a research note to clients.

Not yet. The yield curve inversion reflects what investors believe at the moment, and historical patterns don't guarantee that an event will occur in the future.

The closely watched spread between two-year and 10-year bonds dipped below 0.1 percentage point on Tuesday, the lowest since before the last recession and continuing a slide that began in October.

He added the need for the Federal Reserve to tighten monetary policy as fast as it is signalling had been reduced in recent times due to reduced activity in the United States housing and auto markets, highlighting that consumers are feeling the pinch of higher rates.

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