Bond market's 'yield curve' returns to normal from inverted state that sparked recession fears

The relationship between the 10-year and 2-year Treasury yields briefly normalized on Wednesday, reflecting a classic recession indicator.

Following economic news showing a sharp decline in job openings and dovish comments from Atlanta Federal Reserve President Raphael Bousik, the benchmark index fell The yield on the 10-year note rose above the yield on the 2-year note. For the first time since June 2022.

The returns were respectively around 3.79% during the session, with only a few thousand percentage points difference between them.

An inverted yield curve, where yields on shorter-dated bonds are higher, has been a sign of most recessions since World War II. The reason shorter-dated bond yields are higher than their longer-dated counterparts is primarily because traders are pricing in slower future growth.

But a return to normal doesn’t necessarily mean good times are ahead. In fact, the curve usually returns to normal before a recession sets in, meaning the U.S. could still face some turbulent economic volatility ahead.

“If you don’t have any sense of history when it comes to the economy, there’s no point in saying it’s going to be positive,” said Quincy Krosby, chief global strategist at LPL Financial. “However, statistically, the yield curve will normalize as the economy actually enters a recession or is in a recession simply because the Fed will cut rates” in response to a slowing economy.

The price action came after a Labor Department report showed job openings unexpectedly fell to just under 7.7 million in July, leaving supply and demand roughly even after a severe imbalance since the Covid crisis. Job openings had outstripped labor supply by more than 2-to-1 at one point, fueling inflation that was at its highest in more than 40 years.

Meanwhile, Atlanta Federal Reserve President Raphael Bousik made comments, around the same time as the jobless report fell, indicating that he is prepared to start cutting interest rates even as inflation rises above the central bank's 2% target.

Low interest rates are seen as a boost to economic growth; the Federal Reserve has kept its benchmark interest rate at a 23-year high since July 2023, targeting a range of 5.25%-5.5%.

While the market is closely watching the relationship between the two-year and 10-year yields, the Fed is also closely watching the relationship between the three-month and 10-year yields. This part of the curve remains sharply inverted, with the spread now exceeding 1.3 percentage points.