By: Russ Kamp, Managing Director, Ryan ALM, Inc.
Currently, the US 2-year Treasury Note is trading at an 85 bps premium yield to that of the 30-year US Treasury Bond. This inversion doesn’t happen often and has on many occasions predicted a near-term recession. Is 85 bps significant? Well, yes. According to the Ryan ALM Treasury Yield Curve Indexes, -85 bps is the greatest negative yield spread or slope between 2-year and 30-year Treasuries since April 15, 1982, when the spread was -110 bps. The all-time inversion between 2- and 30-year Treasuries occurred on March 20, 1980, when the inversion reached -281 bps.
What I find fascinating is that -85 bps wasn’t breached in 2000-02, 2007-09, or during the initial Covid-19 crisis. Given that the US Federal Reserve continues to suggest that rates will continue to rise in order to thwart inflation, will the -85 bps differential be maintained, expanded, or contracted? Have market participants discounted the strength of the US labor market which currently has an unemployment rate of 3.7%? As a reminder, the US experienced an unemployment rate of 10.8% in 1982 which was more than 3 times as great as that which we are experiencing today. With full employment and wage growth running at roughly 5%, how likely is it that demand for goods and services will be constricted?
We believe that the Fed will not stop increasing the Fed Funds rate until they actually achieve “real” interest rates. According to Yardeni Research, the average inflation premium (real rates) is 3.06% since 1960. What do you think?