(Bloomberg News) The bond market indicator that has predicted every U.S. recession since 1970 shows that the economy has about a 60 percent chance of contracting within 12 months.
The so-called Treasury yield curve, adjusted for distortions caused by the Federal Reserve's record low zero to 0.25 percent target interest rate for overnight loans between banks, shows that two-year notes yield 20 basis points, or 0.20 percentage point, less than five-year notes, according to Bank of America Corp. research. The unadjusted gap of 79 basis points at the end of last week indicates the chance of recession at about 15 percent.
Short-term rates have been higher than longer-term yields, or inverted, before each of the seven recessions since 1970. A contraction would make it harder for U.S. President Barack Obama to reduce unemployment, which has held at or above 9 percent every month except two since May 2009, including a reading of 9.1 percent in September. It may also help bolster Treasuries and keep yields near all-time lows.
"The adjusted curve is giving a powerful signal for an upcoming U.S. recession," said Ruslan Bikbov, a fixed-income strategist in New York at Bank of America, one of the 22 primary dealers of U.S. government securities that trade with the Fed. "If that happens, the Fed's target rate could remain near zero beyond 2014," more than a year longer than the central bank has indicated, he said in an interview on Oct. 3.
Bank of America's research is sending the same message as the Economic Cycle Research Institute and Bill Gross, manager of the world's biggest bond fund, which say the U.S. may be headed into a decline. Fed Chairman Ben S. Bernanke said last week in testimony to Congress that the central bank can take further steps to sustain a recovery that's "close to faltering" after almost three-years of near-zero interest rates and $2.35 trillion of bond purchases.
The Organization for Economic Cooperation and Development cut its forecasts for the U.S. last month, saying the $15 trillion economy likely grew 1.1 percent in the third quarter and will expand just 0.4 percent in the fourth.
Data last week showed some signs of strength, damping the appeal of government debt. The Institute for Supply Management's factory index climbed to 51.6 last month from 50.6 in August, the Tempe, Arizona-based group said Oct. 3. A level of 50 is the dividing line between growth and contraction. The median forecast of 82 economists surveyed by Bloomberg News projected a drop to 50.5.
The yield on the benchmark 10-year Treasury rose 16 basis points last week to 2.08 percent, the biggest gain since it increased 32 basis points in the period ended July 1. The yield is up from 1.6714 percent on Sept. 23, the lowest since at least 1953. The two-year note yield ended last week at 0.29 percent, and the five-year security's at 1.08 percent.
Ten-year notes yielded 2.12 percent today as of 10:10 a.m. in London, while two-year rates were 0.30 percent and five-year notes yielded 1.11 percent.
Yields on five-year Treasuries exceed two-year notes by 81 basis points. While that is above the low this year of 58 on Sept. 22, the gap has shrunk from a high of 156 on Feb. 10.