One of the most significant recession indicators just occurred last week, the inversion of U.S. Treasuries. It’s not often this happens and when it does it means a recession is going to occur within a year.
Right now, the three-month Treasury yields are higher than the ten-year Treasury yields. Typically, the longer term bonds have a higher return than the shorter terms bonds; however, this isn’t the case so far.
Why Does The Yield Curve Inversion Occur?
Short term economic indicators are rather bleak. After receiving many signs that point to a lousy economy, bond trader foresees a recession soon.
They fear financial risk and want a higher treasury yield to compensate. For now, the bond traders are more optimistic in the long-term and as a result, are buying long term Treasuries.
As investors buy more treasury bonds, the yield on those bonds falls. However, since investors are worried in the short-term, they’re not buying short-term low yielding bonds.
Instead, they’re waiting for short-term bonds yields to increase. While in the meantime they’re purchasing the longer-term bonds, causing yields to fall.
Furthermore, what we have is an inversion of U.S. Treasuries where the short-term bonds have higher returns than the long term bonds.
A Recession In Sight?
The U.S. economy entered a recession within a year during the last seven times that the yield curve inverted. Will the inversion of U.S. Treasuries be right again this time? I believe so; I wouldn’t be surprised if we’re already in a recession.
Sure the unemployment rate is at 3.8%, but everyone knows the government’s unemployment numbers are a farce. However; you can look at various other data, such as the number of home foreclosures January.
One can even look at the number of layoffs and store closures for the year. Another indicator that times are tough is the Federal Reserve’s dovish announcement of calling off rate hikes for the rest of this year.
They also stated that in September they will be ending the shrinking of their balance sheet program. It’s clear that something is wrong with the economy and it’s only a matter of time before we begin to see the next crash.
Is The Bond Market Right About Long Term Treasuries?
As stated previously, the bond market is avoiding the short-term bonds in favor of the long-term treasury bonds. However; are they right? Are the long-term treasuries better than the short-term treasuries or are they both just as bad?
The simple answer is they’re both terrible. Sure, short-term bonds look unfavorable due to recession fears. However, the long term treasuries are just as bad if not worse. The U.S. debt is growing at an ever rapid pace and appears that the obligation will never be paid off.
At some point, the U.S. government will have to confront this issue, and there are only two solutions to this problem. The government can either default or inflate the debt.
Regardless of choice, the value of U.S. Treasuries will be destroyed; leaving bondholders with worthless pieces of paper.
So will this all start with the inversion of U.S. Treasuries? So far, the inversion has a 100% track record, and if I were a betting man, I’d bet it’s going to be right again. So prepare for the worse because it’s about to get ugly.