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The Highly Watched 2-10 Inversion Recession Indicator May Not Be the Best Signal

All eyes are on the 2-10 bond market inversion. What about the 3-30 instead?
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Recession lead times data from St. Louis Fed, calculations and chart by Mish 

Recession lead times data from St. Louis Fed, calculations and chart by Mish 

All spreads are years. For example 3-30 is the 3-year to 30-year spread.  

Recession Start vs Inversion Warning

Recession lead times data from St. Louis Fed, calculations and chart by Mish

Recession lead times data from St. Louis Fed, calculations and chart by Mish

Chart and Table Notes

  • 3-30, 1-10, and 2-10 refer to one-year, 2-year, 3-year, 10-year, and 30-year bond yields
  • Inversion happens when the shorter-duration bond yield is greater than the longer-duration bond yield
  • The 3-30 inversion is very consistent in lead times. However, it did not invert prior to the Covid-19 recession that started in March of 2020.
  • Whereas the 2-10 recession signal varies from six to 33 months, the variance in the 3-30 signal is ten to fifteen months. 
  • The number of months is a date difference calculation by Excel.

A Better Indicator?

  • The 3-year to 30-year inverted on 1982-09-15 but there was no recession.
  • The 3-year to 30-year did not invert prior to the Covid-19 recession that started in March of 2020.

However, both the 3-30 and 2-10 have now inverted. 

Yield Curve Spreads Since January 2021 as of 2022-04-01

Yield curve data from New York Fed, chart by Mish

Yield curve data from New York Fed, chart by Mish

Change Since January 2021 Chart Notes 

  • A year ago the 2-10 spread was 159 basis points (+1.59 percentage points). 
  • On April 1, 2022 the 2-10 spread inverted (-6 basis points). 
  • On March 17, 2021 the 3-30 spread was 213 basis points.
  • On April 1, 2022 the 2-10 spread inverted (-14 basis points), a stunning collapse of 2.27 percentage points in just over a year. 

Yield Curve Spreads Since January 2022 as of 2022-04-01

Yield curve data from New York Fed, chart by Mish

Yield curve data from New York Fed, chart by Mish

Six spreads as shown above are now inverted. The 3-30 spread is -14 basis points. 

Yield Curve to Scale

Yield curve data from New York Fed, chart by Mish

Yield curve data from New York Fed, chart by Mish

Yield Curve Notes

  • The inversions are clearly visible. Also see the 2-year yield is 2.44% the same as the 30-year yield. 
  • The Effective Fed Funds Rate (EFFR) is calculated as a volume-weighted median of overnight federal funds transactions.
  • The front-end steepness will vanish as the Fed hikes rates. 

Treasury Yields 2021 to Date 2022-04-01

Yield curve data from New York Fed, chart by Mish

Yield curve data from New York Fed, chart by Mish

Notice the shape of the 2-year and longer treasuries a year ago vs today. Also note recent falling yields at the extreme long end of the curve (20-year and 30-year).

Dot Plot

Dot plot of Fed rate hike expectations from the FOMC committee, annotations by Mish.

Dot plot of Fed rate hike expectations from the FOMC committee, annotations by Mish.

Scroll to Continue

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Double-Edged Warning

  • Recent action is not only a recession warning, it's a clear warning to those short the long end of the curve.  
  • If the Fed hikes to 2.0% at the end of this year as widely expected, then it's highly likely the entire curve will be inverted.

  • If so, I expect a rally at the long end of the curve, with the yield on the 10-year and 30-year bonds falling. Those expecting otherwise are not paying attention to history.

Some have suggested a steepening of the curve. That tends to happen coming out of recessions not headed into them. 

Coming out of the next recession, treasury bulls may will to re-think deflationary forces (of which there are still many), vs inflationary forces that happen to be increasing.

I have an open mind on this but here are a few inflationary and deflationary points to consider.

Deflationary Points

  • Boomer retirements will destroy demand for things. 
  • Boomers will eventually die leaving a glut of houses. 
  • Stock market decline will destroy a lot of demand.  
  • Government spending is a drag on growth.

Inflationary points

  • Wage gains will not go away even if there is temporary demand destruction due to a recession
  • More military spending globally
  • Push for carbon and fossil fuel elimination 
  • Uptick in unions 
  • Sanction madness is backfiring
  • Just-in-time supply chains are dead
  • Commodity hoarding is underway and may stay that way
  • De-globalization

Globalization was a massive deflationary force. That tide appears to have shifted.

Nothing is set in stone yet, but President Biden has continued President Trump's sanction and tariff madness. 

To punish Russia, commodity costs and supply chain disruptions are massive. 

Everyone First!

America First, China First, EU First, but Russia Last does not exactly work in the real world given the global need for commodities largely controlled by Russia and China. 

Spotlight on De-Globalization 

Global map from Nations Online Project, annotations by Mish

Global map from Nations Online Project, annotations by Mish

For energy supply chain disruptions and de-globalization, please see De-Globalization: New Supply Chains Are Inefficient and Will Drive Up Inflation

De-globalization is underway. A key ramification is higher inflation.

For now, the inflationary forces exceed the deflationary ones. This can change but not if every country thinks it can put itself first while simultaneously punishing Russia.

Meanwhile the yield curve is talking. Are you listening? The 3-year to 30-year spread suggests a recession sooner, not 30 months from now. 

This post originated on MishTalk.Com.

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