The yield curve inverted on Monday amid a tumultuous several days on Wall Street — indicating that a recession may be on the horizon.
The yield curve refers to the relationship between bond maturity and expected interest rates. Normally, a bond with a more distant expiration will have a better interest rate — but with an inverted yield curve, short-term interest rates are higher than long-term ones, reflecting a looming increase in interest rates. A yield curve inversion has only failed to predict a recession one time since 1955, according to the Federal Reserve Bank of San Francisco.
The gap between the two-year and 10-year Treasury yields fell to -0.02% on Monday before rebounding to positive territory, while the gap between five-year and 30-year yields fell as low as -0.15%, per Reuters. The yield curve briefly inverted in March for the first time since 2019 before normalizing once again.
An inverted yield curve historically precedes recessions by six months to two years, as indicated by data from the Federal Reserve Bank of St. Louis.
All eyes are upon the Federal Reserve as it weighs a 0.75% hike in interest rates for the first time since 1994, according to The Wall Street Journal. Rate hikes are meant to discourage inflation, but they carry the unfortunate side effect of increasing borrowing costs and thereby dampening economic activity.
The central bank already hiked rates by 0.5% last month — the largest rate increase since 2000 — after a 0.25% rate hike from near-zero levels three months ago. As employment numbers remain robust, the central bank likely sees the strong labor market as a sign that officials should continue to raise rates throughout the year.
“Given the latest information on inflation, we believe that risk-management considerations call for aggressive action to reinforce the Fed’s inflation-fighting credibility,” analysts from investment bank Barclays said in a commentary, according to Yahoo Finance.
Inflation is top-of-mind for consumers and businesses alike. While the Consumer Price Index (CPI) increased 8.6% year-over-year as of May, the Producer Price Index (PPI) — which monitors inflation for wholesalers — increased 10.8% over the same period.
At the end of last month, President Joe Biden met with Federal Reserve Chair Jerome Powell and Treasury Secretary Janet Yellen in an effort to show that he is serious about rising price levels.
Past commanders-in-chief — including Richard Nixon, Ronald Reagan, and George H.W. Bush — have called for central bankers to avoid rate increases in fears of slowing economic growth, according to Axios. Most recently, Donald Trump pressured Powell to slash rates as the economy began to free-fall amid the spread of COVID-19. Biden’s approach represents a departure from his predecessors as high prices weigh on American consumers ahead of the midterm elections.
Biden expressed his concern with rising price levels in a recent opinion piece for The Wall Street Journal. While saying that he would not “meddle with the Fed,” Biden vowed to make high prices his “top economic priority,” while arguing that the central bank still “has a primary responsibility to control inflation.”
“Americans are anxious. I know that feeling. I grew up in a family where it mattered when the price of gas or groceries rose,” Biden wrote. “We felt it around the kitchen table. But the American people should have confidence that our economy faces these challenges from a position of strength.”