Bond Yields Say Recession Could Be Ahead for U.S. Economy
There’s one important indicator foretelling a recession in the U.S. economy; pay attention to bonds. As it stands, we are seeing something very interesting happening.
Before going into any details, know that basic economics say that, as interest rates increase, bond yields also rise. Yield is essentially how much return an investor earns on a bond.
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It should not really be news to anyone that the Federal Reserve is raising its benchmark interest rates, the federal funds rate (FFR). Also, the Fed is selling the bonds it holds on its balance sheet. Going forward, the Fed is widely expected to raise rates. By 2020, according to the Fed’s projections, these rates are expected to increase to around three percent.
What should we expect when the Federal Reserve is raising rates?
One would assume that yields on bonds would be increasing. With U.S. bonds, however, this is not happening. You see, generally, you would see yields on all bonds going higher at the same time as interest rates move higher. Currently, there’s a massive disparity between interest rates and bond yields.
To provide you with some perspective, consider this: in the last six months, yields on 30-year U.S. bonds have declined by close to eight percent, 20-year bond yields have decreased by 6.52%, and 10-year U.S. Treasury note yields are unchanged.
If you look at the shorter-term U.S. treasury, we see yields spiking higher. For example, six-month U.S. Treasury note yields have increased 39%. Yields on two-year bonds are at their highest level since 2008.
What Does This All Mean?
Now, bringing all of this together…
When trying to predict the state of the economy, economists usually look at a chart called “yield curve.” The yield curve basically plots yields of different bonds, ranging from short-term to long-term. If the curve is trending up, which is referred to as “normal,” it suggests that interest rates will go higher and that economic conditions are fine.
If the curve is trending lower, when short-term bonds have higher yields than long-term bonds, it means the economy is heading for a recession and that interest rates could go lower.
Dear reader, currently we see the yield curve flattening. This is bad news for the U.S. economy.
At its core, yields on bonds are saying that the U.S. economy could be headed for a recession. Obviously, with time, we will know more. The headline economic data still says there’s really no slowdown in the U.S. economy.
Here’s the thing: we are starting to see investors noticing this phenomenon as well. And they are getting concerned.
One place where we see them concerned is in the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), often referred to as the “Fear Index.” Over the past few weeks, we have really seen an upside in that index. Since early November, the VIX has soared by over 30%.
