Yield curve inverts once again on fears the Fed won't save the economy

The main part of the yield curve inverted once again Thursday as the yield on the benchmark 10-year Treasury note traded under that of the 2-year note, the third time the recession indicator has been triggered since last Wednesday.

The move came after Kansas City Federal Reserve President Esther George and Philadelphia Fed President Patrick Harker told CNBC that they don't see the case for additional interest rate cuts after the central's bank quarter-point reduction in July.

The initial inversion on Thursday followed in the immediate aftermath of George's comments, though the spread between the two yield bounced into and out of negative territory throughout the rest of the trading session. As of 4:05 p.m. ET the curve was inverted with the 2-year Treasury yield at 1.614%, above the 10-year at 1.611%.

Such an inversion is viewed by many fixed-income traders as a sign of a future recession, though forecasting the timing of an eventual downturn is a tougher task.

Portions of the U.S. yield curve have inverted over the past several months, but economists consider a negative spread between the 2-year rate and 10-year rate more concerning. That's because inversions of that part of the curve have predated every recession over the past 50 years while the last five 2-10 inversions have all led to recessions.

Esther George: The Fed may be partly responsible for the yield curve inversion
Esther George: The Fed may be partly responsible for the yield curve inversion

The most recent moves in the U.S. bond market came amid the commentary from Fed officials in Jackson Hole, Wyoming, where top central bank officials gathered to discuss challenges to monetary policy during the two-day meeting.

George, for example, told CNBC's Steve Liesman that her sense on monetary policy is that "we've added accommodation and it wasn't required in my view."

"With this very low unemployment rate, with wages rising, with the inflation rate staying close to the Fed's target, I think we're in a good place relative to the mandates that we're asked to achieve," George added.

The Federal Open Market Committee, the Fed's policymaking arm, cut interest rates on July 31 thanks to "global developments" and what it described as "muted inflation." George, however, was one of two voting policymakers who advocated to keep rates unchanged.

Harker, not a current FOMC voting member, said the Fed should wait and see for "a while" before acting to ease rates further. George, meanwhile, is a current voting member.

Those comments — made from the Fed's annual symposium — aggravated Wall Street's fears that the Fed will be too slow to juice the economy should GDP growth contract. Though investors remained confident the central bank will cut again in September, expectations that the Fed will lower rates by another 25 basis points waned Thursday morning.

Traders were pricing in a 90% probability of a 25 basis point cut following Harker's and George's comments, according to the CME's FedWatch Tool, down about 8 percentage points from Wednesday.

George also said Thursday that the central bank's enormous balance sheet — the sum total of the mortgage-backed and Treasury securities it bought during the Great Recession to juice the American economy — could be responsible for the yield curve inversion.

"I think the Fed still has a large balance sheet, and that could be putting some downward pressure on those longer-term rates," she added. "We all know what the history is of inverted yield curves and the concern that they portend a recession coming. But in the context of a global economy that is weakening, I think that could be explaining part of it."

The Fed's closely watched annual meeting comes shortly after the central bank published minutes from its latest meeting on Wednesday.

The July meeting record showed Federal Reserve officials who voted to lower interest rates three weeks ago agreed that the move shouldn't be viewed as an indication that there is a "pre-set course" for future cuts. Mentions of the inverted yield curve, however, were scarce.

While the yield on the 2-year note had yet to top that of the 10-year by the time of the July FOMC meeting, portions of the curve considered of greater predictive power and of higher value to the Fed had already inverted.

Esther George, John Williams and Jerome Powell, at Jackson Hole, Wyoming, August 24, 2018.
David A. Grogan | CNBC

"A few participants expressed the concern that the inversion of the Treasury yield curve, as evidenced by the 10-year yield falling below the 3-month yield, had persisted for about two months," the minutes read. The phenomenon "could indicate that market participants anticipated weaker economic conditions in the future and that the Federal Reserve would soon need to lower the federal funds rate substantially in response."

Meanwhile, a reading from IHS Markit showed that the manufacturing sector was in a contraction for the first time in nearly a decade.

"Manufacturing companies continued to feel the impact of slowing global economic conditions," Tim Moore, economics associate director at Markit, said in a statement Thursday. "August's survey data provides a clear signal that economic growth has continued to soften in the third quarter."

— CNBC's Fred Imbert and Yun Li contributed reporting.