Campbell Harvey was one of the first to historically show the link, with his work on the three-month, 10-year spread—which has inverted before each of the past eight U.S. recessions. These days, the professor at Duke University’s Fuqua School of Business is concerned about growing threats to the U.S. recovery, even though his beloved spread is not yet flashing “code red.”
High inflation and “geopolitical risk—which we haven’t even felt the economic outcome of yet, besides at the gas pump—is all acting like a tax,” Harvey said. “It all indicates slower economic growth.”
For similar reasons, money managers including Yi at Northern Trust and Steven Oh at PineBridge Investments LP are betting the Fed will likely pause policy tightening later this year.
If the Fed decides to tighten in earnest, a further flattening in key sections of the curve looks inevitable—with the next leg possibly powered by a higher three-month Treasury rate. The latter has ample scope to catch up with the policy-sensitive two-year rate, which has already surged past 2% from less than 0.75% at the end of December.
Federal Reserve Bank of St. Louis President James Bullard, regarded as the most hawkish Fed policy maker, continues to call for the policy rate to rise to above 3% this year, citing the 1994 tightening cycle. Back then, the Fed chair, Alan Greenspan, surprised markets with an aggressive policy response—causing the gap between the three-month and 10-year yields to converge—but the continued U.S. expansion ultimately stopped an inversion in its tracks.
All that suggests risks are rising for bond investors, with the spread between five-year notes and 30-year securities shrinking again this week to around levels unseen since before the global financial crisis.
“We have gone from at the start of the year virtually zero chance of recession in 2023 to now maybe around a 25% to 35% probability,” said Oh, global head of credit and fixed income at PineBridge, which manages about $149 billion in assets.
—With assistance from Ye Xie.
This article was provided by Bloomberg News.