“Soft Landing” Narrative Shattered!

Steepest Yield Curve Inversion Since 1981 –

“Soft Landing” Narrative Shattered!

It’s been said that the bond market is more sophisticated, and a better predictor overall, than the stock market. If that’s the case, then bond traders are signaling big trouble ahead – even worse, possibly, than the 2008 financial crisis.

All it took was a few words indicated higher-for-longer interest rates from Federal Reserve Chairman Jerome Powell to Congress, to work the bond market up into a frenzy. The 2-year Treasury note yield spiked to 5.05%, and that’s the highest 2-year yield since 2007.

This was part of a broader rotation into assets perceived as risk-off, as the U.S. dollar had its biggest rally since November 3 of last year. Meanwhile, stock sectors that are particularly sensitive to dollar and bond-yield changes, including energy, materials, industrials, and financials, sold off in the wake of Powell’s testimony.

Let’s not bury the real headline there, though. It’s not every day that the media bothers to report on yield-curve inversions, since many amateur investors don’t understand what this means. However, when the difference between the 2-year and 10-year Treasury yields is at its highest reading since Paul Volcker was the Fed chairman, even the mainstream press can’t ignore it.

We were already living in Bizarro-Land as short-dated bonds aren’t supposed to pay their holders more than bonds involving long-term commitments. Yet, it’s gotten even more bizarre, and more alarming, now that the 2-year Treasury yield (at 5.05%) has moved more than 100 basis points above the 10-year Treasury yield (at 3.97%).

So now, there’s a yield-curve inversion that’s as steep as it’s been since September of 1981. In effect, bond traders are more confident in the U.S. economy in the short term than they are in the long-term outlook – in other words, they see big problems arising down the road.

Their trepidation is entirely understandable. The odds of a 50-basis-point interest-rate hike on March 22, the upcoming FOMC meeting, surged from 31.4% a day earlier to 70.5% after Powell’s testimony to Congress. There will be problems in the economy, and this will be deliberately engineered by the Federal Reserve.

As Powell and the Fed become increasingly hawkish in their language, the 2-and-10-year yield curve could get even more inverted. Really, this is the bond market’s way of anticipating Fed rate cuts down the road due to a slowdown in the economy and a practically inevitable recession.

Now, the perma-bulls in the stock market might contend that a yield-curve inversion, even if it’s very steep, is only an expression of the bond market’s opinion. Yield-curve inversions don’t actually cause recessions – and this is true, but it misses the point.

Even if yield-curve inversions don’t cause recessions, they have consistently predicted or coincided with them. According to Lawrence Gillum, fixed-income strategist for LPL Financial, the past six times the 2-year and 10-year Treasury yields inverted, a recession followed 18 months later on average.

Thus, it’s not a question of “if,” but only a question of “when” a recession will happen in the U.S. Powell won’t be satisfied that inflation will be under control until he sees recessionary conditions, including large-scale job losses. Then, he can crank up the printing press again and restart the rate-cut cycle.

Until then, the rare and unsettling phenomenon of stock and bond prices (not yields) falling simultaneously will likely continue. Investors must, therefore, be agile in their strategy as timing will be of the utmost importance to your profit potential, and even to the preservation of the wealth you already have.