What the bond market is telling us about recession chances right now

Published Tue, Oct 3 202310:28 AM EDT

More than a year after a key part of the so-called Treasury yield curve inverted, it has recently started to steepen, a sequence that many pros on Wall Street still believe could be the true sign of economic trouble ahead. The yield curve inverts when shorter-term Treasury rates rise above longer-term yields. The 2-year and 10-year Treasury yield curve initially inverted in March 2022, a phenomenon that has historically been a reliable recession predictor. It typically takes nearly two years for an economic downturn to occur. Some say the tale-tell sign that a downturn is imminent is when the curve begins to revert back to its proper form, just as what it's doing right now. The spread between the 2-year and 10-year Treasury yields tightened to 40 basis points on Tuesday, marking the smallest gap since May 5. The benchmark 10-year rate just topped 4.7% Tuesday, hitting its highest level since 2007. DoubleLine Capital CEO Jeffrey Gundlach has been watching the bond market for troubling signs. He pointed investors to this movement of the yield curve. "I always talk about the yield curve being inverted as a warning signal if you will... but it doesn't happen imminently. It takes time," Gundlach told CNBC on Sep. 20. "It's usually about 14 months to maybe 18 months after the 2s 10s inverts." The notable bond investor said when the yield curve de-inverts, it's a strong signal of a recession and that it was very close to happening. EvercoreISI historical work found that the yield curve turns positively sloped just before a recession begins. While Wall Street has been bracing for a contraction for much of the past two years, the economy has stayed afloat due largely to a resilient consumer flush with cash and a labor market that has remained solid. However, talks of a recession are heating up again after the Federal Reserve set the tone for a higher-for-longer interest rate regime, pushing up longer-term bond yields. The central bank has taken interest rates to the highest level since early 2001 . The economy may have started to show some signs of weakness. The unemployment rate rose to 3.8% unexpectedly in August, up significantly from July and the highest since February 2022. Pershing Square's Bill Ackman said he believes the economy has begun to decelerate on the back of aggressive rate hikes. ″[T]he Fed is probably done. I think the economy is starting to slow," Ackman said Monday. "The level of real interest rates is high enough to slow things down."