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The bond market flashes a recession warning

While the economy is still growing, economists say a downturn could be months away

Photo (c) peshkov - Getty Images
The bond market is flashing a recession warning, as the yield on the 10-year Treasury bond has fallen below the interest paid on the government’s two-year bond -- a situation known as an inverted yield curve.

That suggests that bond investors want to lock up their money for longer periods of time because they believe rates will fall further in a slowing economy. The increased demand for long-term bonds is what drives down the yield. When fewer investors want short-term bonds, the yield on that bond goes up.

The inverted yield curve does not necessarily cause a recession, but it has preceded every economic downturn over the last 50 years. It shows that most investors believe future rates are headed lower, which typically happens during a recession.

Wall Street has speculated for weeks that there could be a recession in the near future, ending one of the longest economic expansions in modern history. The economy exited the Great Recession in June 2009 and has been growing ever since.

Two consecutive quarters of no growth

A recession is defined as two consecutive quarters of negative growth. In the second quarter of this year, the economy grew by 2.1 percent, mainly due to strong consumer spending. Consumers helped offset a reduction in spending by businesses.

With the economy still growing, why are experts worried about a recession? In a word, “tariffs.” President Trump’s imposition of tariffs on Chinese imports increases the cost of those goods. If things from China cost more, economists conclude that consumers and businesses will buy fewer of them.

At the same time, China’s retaliation with tariffs of its own have hurt U.S. agricultural exports, which puts an economic toll on U.S. farmers. 

The inversion in the yield curve is admittedly minor. In early Wednesday trading, the yield on the benchmark 10-year Treasury note was at 1.623 percent, just below the two-year yield at 1.634 percent.

Lower rates for consumers

One consequence of the bond market’s action is the strong likelihood that the Federal Reserve will cut interest rates again in September. For consumers, that will mean lower interest rates on credit cards and auto loans.

The interest rate paid on Treasury bonds has been falling in recent weeks as foreign money pours into the U.S. market. Rates paid by other developed nations are even lower, prompting investors in other countries to seek the safety and higher yields of U.S. government bonds.

While the inversion spooked the stock market, triggering a wave of early selling, an inverted yield curve does not mean a recession is at hand. According to Credit Suisse, a recession follows an inversion an average of 22 months later.

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