Yield Curve Inversions Flashing Recession Warning Signal

We’ve seen a number of inversions in the Treasury bond yield curve over the last couple of weeks. This is a recession warning signal.

In his podcast, Peter Schiff said the markets are right about the looming recession. But they’re not getting the whole picture.

Typically, longer-term bonds offer a higher yield. So, if you buy a 10-year Treasury, you’ll get a higher interest rate than if you buy a 2-year bond. You are getting paid more for taking the additional risk of buying a longer-term bond.

But last week, the yield on the 5-year Treasury was higher than the 10-year. Then on Monday, the yield on the 5-year Treasury was two basis points higher than the yield on the 30-year.  And on Tuesday, we got an inversion between the 2-year Treasury and the 10-year Treasury.

The last time we saw a 2-year/10-year inversion was in August and September of 2019. At that point, it appeared the economy was slipping toward recession. The Federal Reserve had already cut interest rates and ended its balance sheet reduction. We’ll never know if the economy would have slipped into a recession on its own because of the coronavirus pandemic.

According to Reuters, the recent yield curve inversions once again signal investors are worried about the economy.

Investors are concerned that the Federal Reserve will dent growth as it aggressively hikes rates to fight soaring inflation, with price pressures rising at the fastest pace in 40 years.”

The Fed launched its war on inflation with a quarter-point interest rate hike at the March FOMC meeting. Last week, Federal Reserve Chairman Jerome Powell heated up the rhetoric and signaled the possibility of a 50 basis point hike at the next meeting.

The markets seem to think the tightening will bring on a recession and the Fed will go back to rate cuts in order to juice the economy back into shape. But somehow, this will also solve the inflation problem. In a podcast, Peter Schiff said they are probably correct about the coming recession. But they are getting the rest of the story wrong and the yield curve should not be inverting.

The yields on 10-year and 30-year Treasuries should be soaring despite the fact that we’re headed into recession because inflation is not going to go away.”

Investors seem to think the Fed can kick the can down the road for another 30 years. Peter said there is no way that that’s going to happen.

What we’re witnessing right now is proof that the Federal Reserve has already lost control of inflation. And because they’ve lost control over inflation, the party is over. They can’t continue to kick this can anymore because they no longer have a pretense for zero percent interest rates or quantitative easing. Because all of that was based on the fact that there was no inflation, or that inflation was too low. Clearly, they can’t use that excuse anymore. We have lots of inflation. It’s not too low. It never was too low. But what it is now is much too high, and it’s getting higher. So, there’s no way that the Fed is going to be able to maintain this game for another 30 years.”

In effect, by pricing the 30-year Treasury with a yield of just over 2.5%, the markets are saying they think the Fed will keep interest rates near zero for the next 30 years. They think that every time the Fed tries to raise rates, it will cause a recession. Then the Fed will turn to its playbook, cut rates, and launch QE in order to stimulate the economy again.

The balance sheet keeps growing and growing and growing. First $9 trillion, then $18 trillion, then $50 trillion, $100 trillion, whatever. We continue to play this game of ever-expanding balance sheet, all this money creation. And yet somehow, miracle of miracle, there’s still no inflation. Forget about what we’re looking at right now because that’s just COVID. That’s just Putin. That’s going to go away. We can create all this money, run all these deficits, expand the balance sheet up to infinity, yet inflation is going to stay at zero and investors are going to continue to loan money to the US Treasury at 2.5%. That is crazy. It’s not going to happen. This is blowing up right now and bond investors are going to get killed.”