Narrowing of US Short- and Long-Term Interest Rate Gap... "Low Possibility of Economic Recession"

Shinhan Financial Investment, 'Checking the Path of Inverted Short- and Long-Term Interest Rate Spread' Report
"Fed Shows Willingness to Curb Inflation...Possibility of Further Long-Term Bond Rise ↓"
"US Reaches Full Employment...Expectations for Reopening"

[Asia Economy Reporter Hwang Yoon-joo] Although the yield spread between long-term (10-year) and short-term (2-year) U.S. Treasury bonds is narrowing, an analysis suggests that the possibility of an early inversion of the yield curve due to recession concerns remains low.

Shinhan Investment Corp. stated in a report titled "Reviewing the Path of Long-Short Term Yield Curve Inversion" that "there is limited room for further increases in long-term yields. Conversely, the likelihood of a decline in long-term yields due to recession fears is also low."

◆ Narrowing Long-Short Term Yield Spread... Rising Recession Concerns = Recently, the yield spread between U.S. long- and short-term government bonds has been shrinking, raising concerns. Since 1960, whenever the U.S. long-short term bond yields inverted, a recession followed. Except for the cases in 1966 and 1998, all inversions were followed by recessions within 1 to 2 years.

The yield spread between the 2-year and 10-year U.S. Treasury bonds, which had widened to 158 basis points last year, has narrowed for three consecutive quarters since Q2 2022 and currently stands at about 25 basis points. The yields of the 10-year and 7-year bonds have already inverted, and the 10-year and 5-year yields are close to inversion. The 2-year and 10-year yield spread of the dollar OIS (overnight indexed swap) forward swap, which reflects 1-year ahead interest rate expectations, entered negative territory since February.

In a CNBC survey conducted on the 16th among financial market participants, the probability of a U.S. recession within the next 12 months was estimated at 33%, and for Europe, 50%. Given the sharp narrowing trend since the beginning of the year, there are concerns about a possible inversion and recession in the next 2 to 3 quarters.

The Federal Reserve also assessed in its March economic outlook report that inflation forecast uncertainty is 100%, and the possibility of further rate hikes is 100%. If the market factors in a 50 basis point rate hike in May and the possibility of the policy rate rising to 3% next year as indicated in the March dot plot, the upward trend will continue, potentially leading to a long-short term yield curve inversion in the 2nd to 3rd quarters.

◆ "Limited Room for Further Long-Term Yield Increases... Low Recession Risk" = Min-young Park, a researcher at Shinhan Investment Corp., cited the Fed's commitment to taming inflation as the reason why further increases in long-term yields are unlikely.

Researcher Park said, "Fed Chair Powell mentioned Paul Volcker in Congress, signaling a commitment to controlling inflation," and "If the market maintains the perception that inflation will gradually stabilize due to the Fed's tightening policy from a medium- to long-term perspective, the upper bound of long-term yields will converge to the long-term neutral rate."

Park also assessed that the possibility of a decline in long-term yields due to recession fears is low.

Park analyzed, "The U.S. labor market has reached full employment, and as the COVID-19 situation improved, the previously stagnant labor force participation rate has gradually increased," adding, "This wage and income growth is providing a solid support for consumer spending."

He further diagnosed, "From the second quarter, with the addition of reopening effects, the economy is likely to continue expanding centered on consumption." He explained, "Corporate earnings are also showing resilience, making it difficult to forecast a recession in the short term." Unless issues such as war or COVID-19 worsen and cause economic shocks, the possibility of an early inversion of the long-short term yield spread due to a decline in long-term yields remains low.

This content was produced with the assistance of AI translation services.