Is This Time Different for the Yield Curve?

You might think it sounds crazy when you say it out loud, but there’s a lot of buzz about the yield curve inversion in the stock market. The 1-year treasury rate is now significantly above the 10-year treasury rate, a situation known as an inversion. Historically, this has been a signal of an impending recession, but many economists and market participants are confident that the economy will be just fine. So, what makes this time different?

Let’s take a step back and look at interest rates over the past 45 years. In the 1980s, the Fed’s target rate peaked at a whopping 20%! That was the last time we witnessed inflationary pressures similar to those in 2022. Since then, in each expansionary cycle, the peak interest rates set by the Fed have come in lower. Some argue this is due to lower inflation, but others counter-argue that changes in how inflation is calculated may have played a role. Additionally, the soaring US debt since the 80s has made a significant impact on the cost of servicing that debt, and the government’s spending debates are only getting fiercer.

But is this time truly different? Two major factors stand out:

Inflation: The Fed raised interest rates aggressively in response to the highest inflation in 40 years. This inflation surge was unconventional, driven by pandemic-induced supply chain disruptions and a war in Europe causing an oil shock. It contradicted the recent trend of technology and emerging manufacturing hubs lowering costs. It seems that inflation might be reverting to its long-term direction.

Escalating Debt: The US debt keeps growing, and the debates over spending allocations are intensifying. The more the debt costs, the greater the pressure to interest rates low, both politically and economically.

Fed Funds Rate and US DEBT.

So, when the bond markets ask whether this time is different for the yield curve, their response might indicate that regardless of a recession or not, rates are heading lower. If rates fall as swiftly as the bond market expects, the bullish outlook of no recession might indeed be on target. Only time will tell, but the bond markets seem to have their say on the potential impact.