One of Wall Street’s traditional warning signs for a recession is flashing yellow, and nobody seems to care.
The signal lies within the bond market, where Treasurys maturing in a couple of years have been paying nearly as much in interest as bonds that take a decade to mature. The gap between the two is usually much wider.
Market watchers call this phenomenon a “flattening yield curve,” and it’s often been a harbinger of slowing economic growth, if not a recession.
Earlier this month, a 10-year Treasury was offering just 0.53 percentage points more in yield than a two-year Treasury. The last time the spread was so thin was in October 2007. Two months later, the Great Recession began.
Most Wall Street observers say that technical factors are making the yield curve a less-reliable indicator this time around, and they don’t see a recession looming on the horizon, at least not in 2018.
How can so many along Wall Street feel so confident that this time is different?
Rich Taylor of American Century Investments said the curve is “flattening for different reasons.”
When an economic expansion is several years old and the unemployment rate is low, as it is now, short-term rates are usually moving higher as a result of the Federal Reserve hiking its overnight interest rate.
This year, the Fed has raised short-term rates three times, after doing so just twice in the prior 10 years combined. In response, the yield on the two-year Treasury has climbed to nearly 1.85 percent, up from 1.25 percent at the end of 2016.
But longer-term interest rates have not followed suit. One big reason is stubbornly low inflation.
Raises for workers are a bit healthier than in prior years, and wage growth has historically fed through to higher inflation. But the wage gains are still only modest.
Another factor keeping 10-year Treasurys low is all the buying coming from overseas, said Erin Browne, head of asset allocation at UBS Asset Management.
Of course, if Wall Street is underestimating the predictive power of the yield curve this time around, it may be a while before investors are able to tell. Economists don’t even say a recession has begun until months after its start.
In the meantime, the yield curve’s movements have meant more income for investors whose mutual funds have been buying shorter-term bonds. A two-year Treasury is paying more than triple the interest that it was in the summer of 2016.
Stan Choe writes for the Associated Press.