US Inverted Yield Curve

It seems that bond traders have a gloomy near future American economic outlook. The yields of the long term treasury bonds have dropped sharply lately and the yield curve has been inverted for some time. This means the long term (10 or 30 year) Treasury note yields fell below the shorter term Treasury bonds and Federal Reserve discount rate (at 5.25%) and when this happens, economists say the yield curve is inverted and they forecast recession in the following months. The rationale behind it is related to the behavior of investors who buy more long term bonds than short term ones, thus securing good coupon rates in the long run, while they predict a difficult economic period ahead which might force cutting interest rates in the short run and reduce their potential gain on both long and short term future newly issued bonds. Since bond prices and bond yields are inversely related, when investors buy more long term bonds, their prices rise and their yields fall, as we notice in the charts below:

Above is the chart of the 10 Year Treasury Note and bellow is the chart of the 10 Year Treasury Note Yield (now at around 4.6%).

Therefore, the inverted yield curve predicts recession ahead (as it predicted several times in the American economic history, including in 2000). Nevertheless, the stock market in US is making new highs, approaching the historical year 2000 highs and the dollar is stubbornly strong compared to several months ago (though we cannot ignore the fundamental positive interest rate differential especially against EUR or JPY). Economists say the same happened in 2000 before the recession and this time can’t be different. What’s obvious, though, is the slowing of the American economy (and especially the housing market) which is actually normal due to the high interest rates the FED has arrived at after a strong and measured two year rally. That’s why, at some point, I believe this economic slowdown will also be reflected in the financial markets, (following the commodity markets where this slowdown has already been reflected).