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Analysis-U.S. Treasuries yield curve flashes red to investors -Breaking

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© Reuters. The New York Stock Exchange, NYSE, is seen by people in Manhattan, New York City. August 9, 2021. REUTERS/Andrew Kelly

Megan Davies, Ira Iosebashvili

NEW YORK (Reuters] – Wall Street is being warned by the U.S. Treasury Yield Curve. This warning signal comes after bond investors pushed for higher short-term rates, so that the yields of the Treasury’s two-year Treasury are actually higher than those on the Treasury’s 10-year Treasury.

This phenomenon is called “yield curve-inversion” and investors use it to gauge how the economy will perform. Bond yields have an impact on other assets, which feeds through into bank returns. Apart from the potential economic indicators it can send, the yield curve shape also has many implications for businesses and consumers.

The two-year-to-10 year curve was inverted on Tuesday. This is after several weeks of rapid moves in U.S. Treasury markets. Investors have been selling Treasuries to prepare for aggressive interest rate rises by the U.S. Federal Reserve, which has been fighting rising inflation.

This has been a red flag for investors warning that there could be a recession. It was inverted again in 2019, and it occurred again the next year. The United States went into recession, although this time due to the pandemic.

Campbell Harvey, a Duke University professor of finance, said that many people are focused on this. They see the 10-year/2-year invert as a predictor of recessions and they believe it will happen. So if your company is a business, you reduce capex and make employment plans.

Harvey who narrowed his focus on an area of the yield curve added that it was a good idea to be prepared for a recession so you can survive when it happens.

LPL Financial, a broker-dealer (NASDAQ:), said that the 2/10 Inversion was “a powerful indicator”, pointing out its predates all six recessions starting in 1978 and with only one false negative.

Anu Gaggar from Commonwealth Financial Network is the global investment strategist. She says that the average time it takes for a curve to invert before a recession starts has been around 22 months. However, for the six most recent recessions, this lag has varied between 6 and 36 months.

Investors caution that the yield curve may not be the only indicator to use when forecasting recession. Equity markets have risen in recent weeks after the yield curve was confirmed to be in correction and its annual loss has been reduced by around 3%.

The curve, however, has been a classic signal for market participants.

“There is definitely a psychological element to it,” said Gennadiy Goldberg, senior rates strategist at TD Securities. “The yield curve has worked in the past because it has been a signal that the end of the cycle is coming.”

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Short-term yields on U.S. government bonds have been increasing rapidly in anticipation of an increase in U.S. Federal Reserve rates. However, longer-dated bond yields are rising slowly amid fears that tightening policy may harm the economy.

The Treasury yield curve is therefore generally flattening, and sometimes inverting.

Some people are skeptical that the curve tells the entire story. Some claim that the Fed’s two-year bond buying program has artificially lowered the 10-year yield by inflating the value of Treasuries. The central bank will shrink its balance sheet and increase the slope, causing the yield to go up.

The fact that signals have been sent by different areas of the yield curve can further cloud the picture.

Financial markets view the 2-year yield as an indicator of Fed policy. They closely monitor the 2/10 portion of the curve. However, academic papers support the spread between yields on Treasury bills three months and 10 years. However, this yield curve is not indicative of recession.

Eric Winograd (NYSE:), senior economist at AllianceBernstein, stated that the discussion on inversion of yield curves was too heated.

“I understand the narrative and I think from a risk-taking perspective there is good evidence that a flat or inverted yield curve is a challenge for broader risk assets but I am not going to worry more about a recession if the yield curve inverts by 5 basis points or doesn’t,” Winograd said.

Investors could be more skeptical of inversions this time because the Fed is still very early in its hiking cycle and has time to reduce the pace if there are signs that the economy may slip into a downward turn, TD Goldberg explained.

Researchers at the Fed, meanwhile, put out a paper https://www.federalreserve.gov/econres/notes/feds-notes/dont-fear-the-yield-curve-reprise-20220325.htm on March 25 that suggested the predictive power of the spread between two- and 10-year Treasuries to signal a coming recession is “probably spurious,” and suggested a better herald of a coming economic slowdown is the spread of Treasuries with maturities of less than two years.

Nevertheless, some people cannot ignore the trend.

“When things invert you are definitely much closer to a recession than a good outcome and that’s exactly where we are today,” said Edward Al Hussainy, senior interest rate and currency analyst at Columbia Threadneedle. “It’s clear we have arrived at a point of stress in markets.”

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