The yield on the 10-year U.S. Treasury note dropped below that of the two-year Treasury note, creating the largest inversion in the yield curve since 1981. Historically, a yield curve inversion between these two Treasury notes has signaled an oncoming recession. As 2023 approaches, this recession signal could be indicating another tumultuous year.
The spread between 2- and 10-year Treasury yields reached one of its most negative levels, at -76 basis points, as of November 30, 2022.
Gibson Smith, founder and chief investment officer of asset management firm Smith Capital Investors, told Barron’s, “The yield curve is confirming a growing consensus view that the economy is in trouble and that the [Federal Reserve] is going to blow it.” Smith was referring to the central bank’s efforts to curb high inflation by reducing market liquidity and raising interest rates.
Typically, in order to protect against the risks of holding onto debt for longer periods of time, yields on short-term debt are lower than yields on long-term debt. When this correlation inverts, it is considered a sign of bond market participants expecting volatility in the near term.
Bleakley Financial Group Chief Investment Officer Peter Boockvar characterizes the large inversion as “a bet that it’s an inevitability that with a higher cost of capital, the U.S. economy has to slow and most likely contract.”
Major banks are warning that the stock market may be vulnerable.
According to strategists from Goldman Sachs, stock market prices have not properly factored in the risk of a recession. In a note published on November 28, 2022, the strategists predicted that stocks will decline another 10% if the U.S. enters a recession.
A more dire prediction came from Bank of America analysts, who warned that the S&P 500 Index could tumble another 24% from current levels, saying the potential outcome would come as a consequence of Federal Reserve policy.
Other financial professionals are also predicting a recession.
A survey conducted by Bank of America shows that 92% of fund managers expect a period of high inflation and low economic growth next year. The same survey found that 0% of respondents expect a situation where the economy both avoids a recession and experiences a slowdown in inflation.
S&P Global Ratings economist Beth Ann Bovino predicted a “mild” recession akin to the 1969/1970 recession in a note released on November 28, 2022. Bovino attributes the “dimming” possibility that the U.S. will avoid a recession to tightened Federal Reserve policy.
Analysts say economic volatility is likely to carry over into 2023 and impact markets. Risk-averse consumers may wish to reassess their portfolio diversification strategies to compensate.
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