US Treasury Yield Curve Flattening: "Premature to Interpret as Economic Slowdown or Recession Signal"

10-Year and 2-Year Bond Yield Spread Hits Lowest Level in Over 2 Years

[Asia Economy Reporter Seo So-jeong] Recently, the spread between long-term and short-term U.S. Treasury yields (10-year minus 2-year) has narrowed to its lowest level since the pandemic, raising concerns about a possible future inversion of the yield curve and an economic slowdown.

According to the "Market Assessment on the Recent Narrowing of the U.S. Treasury Long-Short Yield Spread" released on the 18th by the Korea Eximbank's Foreign Exchange Operation Department, the difference between the 10-year and 2-year U.S. Treasury yields has fallen to its lowest level since March 2020. Since the 11th, an inversion between the 10-year and 7-year Treasuries has persisted, and on the 16th, an inversion also occurred between the 10-year and 5-year yields during intraday trading.

The narrowing of the long-short yield spread has continued since March last year, when the possibility of interest rate hikes by the U.S. Federal Reserve (Fed) became prominent. Especially, the pace of narrowing accelerated with the Fed's monetary policy normalization stance at the beginning of this year. On March 31 last year, the U.S. long-short yield spread expanded to 158 basis points (1bp = 0.01 percentage points) but then began to narrow, reaching about 26bp on the 17th, the lowest since March 10, 2020. This represents a decline of 132bp from the peak.

The Bank of Korea explained, "Since the 1980s, an inversion of the long-short yield spread has occurred before all six recessions (in 1980, 1982, 1991, 2001, 2009, and 2020), leading some to suggest the possibility of a recession." However, "the 2020 recession was influenced by the COVID-19 pandemic, so there is debate about whether the yield curve inversion in 2019 served as a predictive indicator as in previous cases."

Major investment banks generally assess that the recent narrowing of the yield spread is difficult to interpret as a precursor to a recession. Rather than being a result of falling long-term yields due to economic concerns, it is argued that the Fed's rapid shift toward monetary policy normalization has been quickly reflected in short-term bond prices. Additionally, it is noted that yield curve inversions typically occur in the later stages of a rate hike cycle, whereas we are currently in the early phase of the rate hike cycle.

There is also a view that the usefulness of yield curve inversion as a recession predictor has weakened compared to the past. Structural factors such as aging and declining productivity have lowered the neutral interest rate level, and the lower the absolute level of the neutral rate, the more mechanically likely an inversion of the yield spread becomes due to Fed rate hikes. Strong demand for U.S. long-term bonds and increased interest rate volatility due to liquidity constraints also support this perspective.

Goldman Sachs, JP Morgan, and others have evaluated that the U.S. economic conditions remain favorable, considering upward revisions in corporate earnings forecasts and robust household consumption. Major investment banks recognize prolonged inflation effects due to geopolitical risks as the main risk factors rather than the long-short yield spread itself. They foresee that if the Ukraine crisis and sanctions on Russia lead to rising energy prices, causing stagflation (economic stagnation accompanied by inflation) pressures, the yield curve could invert this year, increasing concerns about a recession.

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