Good News: A Fed Rate Cut May End the Inverted Yield Curve

Then, the 3-month Treasury could dip below the 10-year, and dispel this dreaded recession portent.

If the Federal Reserve delivers a long-anticipated interest rate cut Wednesday and maybe one or more in the future, a big problem could well be solved: The yield curve would no longer be inverted.

Since May, the three-month Treasury bill has yielded more than the 10-year Treasury note. When short-term pays out more than long-term, it almost always means that a recession is on the way.

While some question whether the inverted yield curve still has its old predictive powers, the Fed’s slicing the benchmark overnight rate by a quarter percentage point likely would lower the three-month bill to below the 10-year note.

The spread between them is narrow, so the difference would be more pronounced if the three-month descends. As of market close Tuesday, the three-month yielded 2.08% and the 10-year 2.06%. Assuming the 10-year stays in roughly the same place (it has been below the 2% mark in the past), then the three-month might drop to 1.85%. Voila: The inverted curve gets un-inverted.

And a half-point Fed cut—which could come Wednesday in one package, or the Fed may follow later with another quarter-point decrease to get there—likely would bring the three-month down to around 1.6%, even further away from the 10-year. “That would cure the yield curve problem,” said Scott Colyer, CEO of Advisors Asset Management.

After a 10-year economic expansion, talk has been rife that a downturn is overdue. Yes, amid a low unemployment rate (3.7%), strong consumer confidence, and a still-growing gross domestic product (2.1% in June, down a point from May but not bad), a recession is hard to figure at this point. Trouble is, this monster has a way of sneaking up on us.

Corporate America is a lot less sanguine about the future. Business spending has flagged. And the Duke University survey of chief financial officers recently discovered that 69% expect a recession by the end of next year.

True, one might argue that the 10-year’s yield is being held artificially low by its status as a haven asset: Investors overseas, where the economic picture is darker, have been crowding into this Treasury bond. That pumps up its price and depresses its yield.

Indeed, some critics believe that a small Fed move Wednesday will be ineffectual to a $21.3 trillion economy. But if it rights the yield curve, such an adjustment would at least ease some worried minds.

Related Stories:

Inverted Yield Curve Puzzle: Higher Short-Term Yields

Inverted Yield Curve Warning: Is It Different This Time?

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