Treasury Curve Inversion Has Even More To Come Than Feared

Tyler Durden's Photo
by Tyler Durden
Friday, Nov 25, 2022 - 08:05 PM

By Ven Ram, Bloomberg Markets reporter and analyst

One of the most-watched segments of the US yield curve is now caught in the throes of the biggest inversion since the 1980s.

Ten-year Treasuries now offer a yield that is about 77 basis points lower than the two-year maturity. Still-to-come tightening from the Federal Reserve is holding front-end yields higher, while concerns about an economy losing momentum are spurring investors toward longer-dated notes.

While it may be tempting to draw far-reaching conclusions about the depth of the inversion, the evidence is that it reflects that interim state of play where the economic narrative hasn’t yet gone completely pear-shaped. That is especially the case with the labor market, which is still extremely tight from all available evidence. Simultaneously, inflation in this economic cycle is a beast whose contours are yet hard to fully fathom, and it would be premature to equate a peak in price pressures with a headline print that is somewhere where the Fed would want it to be.

While the markets have been quick to run ahead with the idea of an end to Fed tightening, the story just ain’t as simplistic. My two cents is that the Fed will pause on rates once it reaches circa 5%-5.25% and then watch how the economy evolves. If the inflation cookie crumbles, then the early birds may have something to show for their risk-taking ability, but if it doesn’t, the chance that we get into a second stage of further tightening from thereon can’t be ruled out. After all, history shows us that the Fed hasn’t been able to conclude its hiking cycle any time before inflation-adjusted policy rates reached a full 200 basis points. For the record, that rate is now -90 basis points.

The import of all this is that the yield curve is likely to invert even more in the days to come as markets wait for that conclusive inflection point on the economy and inflation.