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The countdown to a recession has officially begun after ‘more accurate’ yield curve indicator turns negative

  • The countdown to an economic recession as begun after the 3-month and 10-year yield curve finally inverted.
  • Research firm TS Lombard expects a recession to hit the US economy within the next 12 months.
  • “The 3m10y [yield curve] is important because it has historically been more accurate at predicting recessions,” TS Lombard said. 

The countdown to an economic recession in the US has officially begun after the 3-month and 10-year US Treasury yield curve inverted, according to a Wednesday note from research firm TS Lombard.

An inversion in the curve happens when the shorter-term yield of a US Treasury note rises above a longer-term Treasury yield. Typically, longer-term bonds command higher yields than short-term bonds. But when economic uncertainty is high, investors demand a premium for shorter-dated bonds.

Inversions have long been seen as a signal that an economic recession is on the horizon, and they’ve already happened across other timeframes, including the closely watched 2-year and 10-year curve.

But according to TS Lombard, the 3-month and 10-year curve is significant because “it has historically been more accurate at predicting recessions.” The 3-month yield first crossed above the 10-year yield on October 25, and has held steady since then with an ongoing spread of nearly 10 basis points.

On Wednesday, the 3-month Treasury yield rose two basis points to 4.15%, compared to the 10-year Treasury yield of 4.08%. 

A recession is likely to hit the economy in the next 12 months — by October 2023 — according to TS Lombard, though it could come slightly sooner or later.

“On average, a recession starts 12 months after the 3m10y curve inverts. But it has also taken as long as 22 months or as little as five months,” TS Lombard’s Skylar Koning said. 

A recession is now seen as inevitable by many, given that the Fed is on track to raise interest rates by more than 400 basis points this year to tame inflation. And a recession is often seen as the only way to truly tame inflation, by destroying demand.

“As the Fed hikes and purposefully dampens demand to bring inflation down, the outlook for growth worsens. Thus, inversion reflects optimism that the Fed will do enough to bring inflation down but also that tightening will mean growth falls to the point that the Fed will have to cut,” Koning said. “And, historically, the Fed cuts shortly after their final hike (on average eight months thereafter).”

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