Yield curve inversion revives concerns over economic slowdown

Asia shares ease as doubts emerge over Sino-US trade war truce

This Market Indicator That Frequently Signals a Recession Just Flashed Red

"The focus is now shifting to the inverted United States bond yield curve, which has negative connotations, while implying the USA economy is heading towards what was, only a few weeks ago, an improbable economic slowdown", said Stephen Innes, head of trading for APAC at Oanda.

Adding to worries over the outlook for the global economy, the yield curve between USA three-year and five-year notes, and between two-year and five-year paper inverted on Monday - the first parts of the Treasury yield curve to invert since the financial crisis, excluding very short-dated debt. And the reason has something to do with an occurrence that is not exactly in the everyday investor's lexicon: an inverted yield curve.

That's in part because investors expect the Federal Reserve to raise interest rates in the future as the economy and inflation power higher.

On December 4 the yield curve signaled caution and, along with worries about global trade and interest rates, it helped send the stock market to one of its worst days of the year. Sometimes, yield curves can become inverted, a scenario in which short-term yields are higher than long-term yields.

According to the San Francisco Fed, each of the nine US recessions that have occurred since 1955 came between six months and 24 months after a an inversion in the yield curve of two-year and 10-year Treasury yields.

The difference between the two-year and the 10-year Treasury yields hasn't yet inverted, although it has flattened to 11 basis points-that is, 11 hundredths of a percent-from 25 basis points last Wednesday.

No, at least not yet. But even before the trading day ended, major US indexes pulled back from intraday highs as investors pondered unresolved issues between the two countries. The job market is strong, and consumer confidence is still high.

"This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that", Ian Lyngen, the head of united rates strategy at BMO Capital Markets, told CNBC.

The bad news for investors is that inverted yield curves have preceded each of the past nine US recessions. Of course, that's still "pretty doggone tight", said Randy Frederick, vice president of trading and derivatives at Charles Schwab. A year ago, the cushion was at 0.62 percentage points.

The Cleveland Fed, meanwhile, has focused on the difference in yields between three-month Treasurys and 10-year Treasurys. An inversion in that part of the curve has preceded each of the last seven recessions. For U.S. investors, the most commonly referenced yield curve is a plot of 2-year and 10-year Treasury yields, which have yet to invert at this point. Even if the more important parts of the yield curve flip to inversion, that doesn't mean a recession will happen the next day. Inverted yield curves have historically occurred during periods of economic recession. On Tuesday, the Dow Jones Industrial Average fell almost 800 points, or 3.1%, largely in response to recession fears stoked by recent changes in the yield curve.

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