The White House says an inverted yield curve doesn't indicate a coming recession. Economists beg to differ.
Three times in roughly the past week, the yield on 10-year U.S. Treasuries has dropped below, or inverted, that of two-year Treasury bonds. When interest rates on short-term debt rise above those on long-term debt, this indicates that investors expect growth to slow in the future, and an inverted yield curve historically has been a recessionary precursor.
White House trade adviser Peter Navarro pushed back on worries that the American economy is softening, saying in a Sunday interview with CNN that the short-lived inversion last week didn’t really count.
“An inverted yield curve requires a big spread before short and long,” he said. “All we have had is a flat curve.”
In reality, the size of the spread is less important than the macroeconomic signal it sends about investor sentiment, said Andrew Thrasher, portfolio manager for Financial Enhancement Group and founder of Thrasher Analytics.
“To say that the inversion didn't happen at all because there wasn't ‘significant spread’ is wrong,” he said. “The reason the actual degree of the spread is secondary — at best — is because the inversion itself speaks to the investing public's opinion on fixed income.”
“Just the fact that yields on the two-year and the 10-year are as close as they are isn’t exactly a warm and fuzzy feeling from an economic outlook,” said Greg McBride, chief financial analyst at Bankrate.com.
“It’s worrisome if the yield curve is flat, and to concentrate on the technical details is kind of missing the forest for the trees,” said Ben Page, senior fellow at the Urban-Brookings Tax Policy Center. “Lots of things can influence domestic interest rates… but it’s difficult to imagine interest rates falling if the economy stays strong,” he said.
Dan North, chief economist at Euler Hermes North America, said robust economic growth would almost certainly produce a steepening of the yield curve. “I don’t know how one can leap from a strong economy to a flat yield curve,” he said.
There is also a secondary key yield curve metric, which is the spread between yields on three-month versus 10-year Treasuries. On Thursday, that was roughly four-tenths of a percentage point — but with the three-month yield being the larger of the two numbers.
“If you look at the 10-year to three-month spread, that’s been inverted since May and keeps getting deeper. So the argument that the 10- to two-year inversion wasn’t significant, I just don’t buy,” North said.
The White House has blamed other central banks’ rate-cutting for pushing down Treasury yields more broadly. “The question is being asked, why are we paying much more in interest than Germany and certain other countries?” President Donald Trump tweeted on Thursday.
Rates in many other developed nations are near zero or have even dipped into negative territory, so bond investors are better off, on a relative basis, investing in the U.S. The German central bank issued a recession warning this week, and its 10- and 30-year bonds have negative yields.
The administration’s contention that demand for U.S. debt distorts the market doesn’t hold water, economists say. Rather, the flight to U.S. Treasuries — the world’s investment of last resort — indicates the extent to which investors are worried about the economy, and the perceived lack of safe harbors in the event of a downturn.
“As low as our yields are, they’re still head and shoulders above the yield you’ll get in any other developed market, so that just further enhances the appeal of the U.S. as a safe haven,” McBride said. “If people aren’t concerned about the economy, they’re not looking for safe haven investments.”