The difference between the 10-year U.S. Treasury yield and the 2-year Treasury yield is the lowest in more than two years.
This years 10-year and 5-year bond yields reversed during the day
Major U.S. IBs “Worried about a downturn in geopolitical risk impacts”
Wall Street in New York, USA [Yonhap News] Major overseas investment banks are paying attention to the narrowing of the difference between the long-term and short-term yields of 10-year U.S. Treasury bonds and 2-year bonds. This is because, in general, the narrowing of the short-term interest rate differential is interpreted as a signal of economic downturn.
Major investment banks do not expect an immediate recession due to the narrowing of the short-term interest rate gap. However, if inflation continues due to Russias invasion of Ukraine, it could lead to increased stagflation pressure.
According to the Recent Market Assessment of Short-Term and Long-Term U.S. Treasury Interest Rates, published by the Bank of Koreas Foreign Investment Management Service on the 18th, the difference between the yield on the 10-year Treasury note and the yield on the 2-year Treasury bond widened to 1.58 percentage points on March 31, last year. Since then, it has been reduced to 0.26 percentage points as of March 17 of this year.
Also, since March 11 of this year, the inversion phenomenon between the 10-year Treasury note and the 7-year Treasury note has continued. The BOK analyzed that the narrowing of the long-term and short-term yield gap on US Treasury bonds has continued since March last year, when the possibility of a rate hike by the Fed was highlighted. In particular, the extent of the contraction is expected to increase as the Feds stance to normalize monetary policy accelerates earlier this year.
Trends in the Long-Short-Term Interest Rate Difference of US Treasury Bonds [Source, Bank of Korea] As the short-term interest rate differential of US Treasury bonds continues to narrow, some are citing the possibility of an inversion of the short-term yield difference, raising the possibility of an economic downturn. According to the Bank of Korea, the short- and long-term interest rate differential inversion occurred in all of the six economic recessions since the 1980s: 1980, 1982, 1991, 2001, 2009, and 2020.
However, major investment banks are judging that the recent narrowing of the interest rate gap is unreasonable to interpret as a harbinger of an economic downturn. This is because the recent narrowing of the short-term interest rate gap is not a result of a fall in long-term bond yields due to economic concerns, but rather a result of the Feds normalization of monetary policy being reflected in short-term bond prices.
Bank of America analyzed that it should be taken into account that the US Federal Reserve is now in the early stages of rate hikes, whereas long-term interest rate inversions occur mostly after interest rate hikes. JP Morgan analyzed that the US economic conditions are still favorable in light of the upward revision of corporate earnings forecasts and brisk household consumption, and that it will be able to withstand the Feds rate hike.
Major investment banks viewed prolonged inflation due to geopolitical risks as a major risk factor rather than the long-term interest rate differential itself. Bank of Montreal and others analyzed that if the Ukraine crisis and Western sanctions on Russia are intensifying than expected, and the resulting increase in energy prices leads to stagflation pressure, the yield curve is highly likely to invert and concerns about an economic recession will increase during this year.