NEW YORK (Reuters) – A portion of the US Treasury's return curve "inverted" this week and interrupted the debate as…
NEW YORK (Reuters) – A portion of the US Treasury’s return curve “inverted” this week and interrupted the debate as to whether it delivers a classic signal of upcoming recession or it has just developed a short-term kink that can be explained for technical reasons .
PHILPHOTO: North side of US Treasury Building in Washington February 22, 2001
For whatever reason, investors and economists ignore this message from the bond market in their danger: yield curve inversions – when shorter dated securities yield more than longer maturities – have preceded every US recession in the last memory, anywhere from 15 months to about two years.
“The yield curve has sent a chill down investor spines in relation to the future outlook for the US economy,” said Chad Morganlander, senior portfolio manager at Washington Crossing Advisors in New Jersey. “That’s what-about-scenario.”
This week’s inversion has certainly been limited so far until the end of the return curve, rather than more carefully studying the recession as the gap between 2 and 10 year-year-longs. In the present case, the return on 5-year banknotes US5YT = RR has fallen below those of both 2-year US2YT = RR and 3-year US3YT = RR securities.
However, in December 2005, a comparable inversion was followed at the top of the curve following an inversion between 2- and 10-year exchanges. The major recession began in December 2007.
That pattern was also apparent since 1988 before the 1990 recession. Before the 2001 recession, the entire synchronization curve fell in February 2000.
GRAPHIC: US yield curve: 2 years to 10 years and 3 months and 10 years – tmsnrtrsrszzqqiW  TECHNICAL GLITCH OR BASIC WARNING?
In today’s case, investors and economists are debating whether this warns of economic weakness ahead or if it reflects other factors, such as a recent reversal of large speculative bargaining on lowered bond prices and the Federal Reserve’s large holdings of Treasury bills.
A key focus is whether the market means that others guess Fed, who has raised interest rates for three years and is expected to lift them further, even at the next meeting in two weeks.
Jeffrey Gundlach, CEO of DoubleLine Capital and a related bond investor, comes down to the fact that it is a basic signal. It reflects the “total bond market mistrust in the Federal Reserve’s earlier plans to raise interest rates until 2019”, he told Reuters.
At the same time, the week’s movement coincides with an ongoing positioning change in the financial market.
Hedge funds and other speculators had accumulated a record level of government bond reductions in the futures market, with the heaviest bets submitted against 5-year maturities. But they have slashed them with more than half in recent weeks, and it may have contributed to the big rally in special 5-year benchmark prices. Bond prices and returns move in opposite directions.
“Much of it’s momentum,” says John Canavan, marketing strategy with Stone & McCarthy Research Associates in New York. “I think it’s exaggerated with short-circuiting and settlement of money-losing positions.”
Another current factor that was absent in previous inversion episodes is Feds $ 3.92 billion stock of bonds accumulated to mitigate the effects of the 2008 financial crisis. While shrinking its holdings for more than a year, its bond portfolio is the world’s largest and is seen as a force to suppress longer-dated exchanges.
GRAPHIC: Obligations of traders in hedge funds in US bonds futures – tmsnrtrsrs / 2RAGqKo
These potential explanations aside, the United States economy is the middle of its second longest expansion on record and economists and investors are aware that a decline is inevitable.
Certain business areas such as cars and housing are partly falling due to rising interest rates, while debt-burdened companies have raised the question of whether they can keep their debt payments as borrowing costs rise.
Fed officials have cited this trend looking to see, but several of them have repeatedly warned the reversal of the return curve as the most reliable indicator that a recession is on the horizon.
Some traders said that the dramatic curve flattened may be excessive and can return if the government’s November payroll reports on Friday would show solid jobs and wage increases.
Although the risk of the entire return curve grows in anticipation of slower domestic growth, the economy looks like a stable labor market and mild inflation.
Last year’s massive federal tax cut has strengthened corporate confidence, but trade tensions between Washington and the major trading partners in the United States arise as a possible economic move, analysts say.
And although the latest kink in the yield curve really is the first signal of a decline many suspects, it does not indicate when it actually begins or how difficult it will be.
“It’s a sloppy predictor, because at some point after a return curve you can get a recession that could be a year, two years, three years,” says Nicholas Colas, founder of DataTrek Research in New York. “And what it means for marketing, you can still have another very solid year after inversion.”
GRAPHICS: Some of the US Treasury curve has already inverted – tmsnrtrsrs / 2Qe7Fxu
GRAPH: US Treasury Bill continues to plot – reut.rs/2MyknFQ  Reporting by Richard Leong; Further reporting by Jennifer Ablan and Chuck Mikolajczak; Editing Dan Burns and Lisa Shumaker