A negative spread between the 10-year and 2-year Treasury yield is traditionally viewed as a precursor to a recession. Yet, the yield curve has been inverted for 484 days, while the US economy demonstrates remarkable strength. Q3 GDP growth stood at 4.9% annualised and the labour market remains tight.
However, it is crucial to note that recessions typically commence when the yield curve steepens following an inversion. Since reaching a spread of -108 bps in June, the curve has steepened by 90 bps. So, is this a signal of an impending recession? Our perspective is mixed. In previous cycles, a steepening into recession usually resulted from the short end of the yield curve falling faster than the long end due to central bank rate cuts. Currently, we are experiencing a “bear steepening”, with the long end rising faster than the short end, reflecting a re-evaluation of growth and inflation expectations. Although this diverges from the patterns seen in the last recessions, it could still lead to an economic downturn, reminiscent of the 1970s’ high inflation environment. We anticipate that the tightening financial conditions caused by the bear steepening will lead to lower prices for risk assets and increase the risk of a credit default cycle. We maintain a short position on credit risk and a long position on duration, particularly focusing on the eurozone, where the economy is contracting more swiftly and inflation pressures are subsiding.
