NEW YORK (Reuters) – Part of the U.S. Pat. Treasury yield curve "inverted" this week, setting it aside.
FILE PHOTO: The north side of the U.S. Treasury Building in Washington February 22, 2001./File Photo
Whatever the reason, investors and economists ignore this message from the bond market at their peril: yield curve inversions ̵
"The yield curve has sent a chill down investors' spines. Economy, "said Chad Morganlander, senior portfolio manager at Washington Crossing Advisors in New Jersey. It's the what-if scenario. "
To be sure, this week's inversion has been limited so far to the front-end of the yield curve rather than more closely studied recession harbingers as the gap between 2-year and 10 -year note yields. In the current instance, on 5-year notes, US5YT = RR has dropped below those on both 2-year US2YT = RR and 3-year US3YT = RR securities.
Still, in December 2005, for instance, a comparable inversion at the front of the curve which subsequently followed by an inversion between 2- and 10-year yields. The Great Recession began in December 2007.
That pattern was also evident in late 1988 in advance of the 1990 recession. Ahead of the 2001 recession, the entire curve dropped into inversion in sync in February 2000.
GRAPHIC: U.S. Pat. yield curve: 2-year to 10-year and 3-month and 10-year – tmsnrt.rs/2zUqXiW
TECHNICAL GLITCH OR FUNDAMENTAL WARNING?
In the current instance, investors and economists are debating whether or not they are considering other factors, as a recent reversal of large speculative pressures on the Federal Reserve's large holdings of treasuries.
The Federal Reserve, which has been published for three years and is expected to attend another meeting, will also discuss the next two weeks.
Jeffrey Gundlach, chief executive officer of DoubleLine Capital and a closely watched bond investor, comes down on the side of being a fundamental signal. It reflects "total bond market disbelief in the Federal Reserve's 2019 plans to raise rates," he told Reuters.
At the same time, this week's move does coincide with an ongoing positioning shift in the Treasury market.
Hedge funds and other speculators have amassed a record level of bets on treasury prices through the futures market, with the heaviest bets lodged against 5-year maturities. But they have slashed those by more than half in the last few weeks, and that may have contributed to the out-sized rally in 5-year note prices in particular. Bond prices and yield move in different directions.
"A lot of it's momentum," said John Canavan, market strategist with Stone & McCarthy Research Associates in New York.
Another current factor that is absent in previous episodes is the Fed's $ 3.92 trillion stockpile of bonds accumulated to soften the effects of the 2008 financial crisis , While it has been shrinking its holdings for more than a year, its bond portfolio remains the largest and largest part of the world.
GRAPHIC: Commitments of traders on hedge funds' positions in U.S. Pat. bond futures – tmsnrt.rs/2RAGqKo
RECORD ECONOMIC EXPANSION
Those potential explanations aside, the U.S. economy is in the middle of its second-longest expansion on record, and economists and investors are mindful that a downturn is inevitable.
Some business sectors like car and housing are flagging due to rising interest rates, while debt-laden companies have raised concerns.
Fed officials have come to the conclusion that this is the most reliable indicator of the inversion of yield curve.
Some traders said the dramatic flattening may be overdone and may revert to the government's November payrolls report.
While the risk of the entire yield curve is rising, the economy is on the verge of ending its growth.
Last year's massive federal tax cut has bolstered business confidence, but trade tension between Washington and major U.S. trade partners looms as a possible economic drag, analysts said.
And even if it does not begin, it does not indicate when it will begin.
"It's a sloppy predictor because at some point after yield curve inversion you could get a recession that could be one year, two years, three years," said Nicholas Colas, co-founder at DataTrek Research in New York.
GRAPHIC: Part of the U.S. Treasury curve has already inverted – tmsnrt.rs/2Qe7Fxu