US yield curve flashing more warning signs of recession risks ahead

“The US government bond market is sending a fresh batch of signals that investors are increasingly convinced the Federal Reserve's aggressive actions to tame inflation will result in recession,” per Reuters analysis published early Thursday morning in Asia.

Key quotes

While Fed Chair Jerome Powell on Wednesday said that he does not see the economy currently in a recession, spreads between different pairings of Treasury securities - and derivatives tied to them - have in past weeks moved into or toward an "inversion" when the shorter dated of the pair yields more than the longer one.

These join another widely followed yield spread relationship - between 2- and 10-year notes - that has been in inversion for most of this month. 

Some of those moves reversed slightly on Wednesday, with rates at the short end of the curve turning lower on expectations of the Fed being less likely to continue with super-sized hikes.

The curve is indicating that the Fed will have to start cutting rates after hiking.

The part of the U.S. Treasury yield curve that compares yields on two-year Treasuries with yields on 10-year government bonds has been inverted for most of the past month and is around the most negative its been since 2000 on a closing price basis.

Fed economists have said that near-term forward yield spreads - namely the differential between the three-month Treasury yield and what the market expects that yield to be in 18 months - are more reliable predictors of a recession than the differential between long-maturity Treasury yields and their short-maturity counterparts.

Futures contracts tied to the Fed's policy rate showed this week that benchmark U.S. interest rates will peak in January 2023, earlier than the February reading they gave last week.

FX reaction

The analysis questions the market’s risk-on mood after the Fed’s 0.75% rate hike, which in turn weighs on the S&P 500 Futures despite the upbeat performance of the Wall Street benchmarks.