LIVE MARKETS-Flattening US yield curve signals higher recession risk, but no alarm yet
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FLATTENING US YIELD CURVE SIGNALS HIGHER RECESSION RISK, BUT NO ALARM YET
The flattening of the US Treasury yield curve since the Federal Reserve turned hawkish points to a clear rise in the risk of recession over the next two years. However, real-economy data has yet to confirm the warning, according to Dominique Dwor-Frecaut, chief US economist at Macro Hive.
The gap between 10-year and 2-year yields has compressed to 40 basis points, much tighter than its 50-year average of about 85 basis points, and implies a 31% chance of a recession within 24 months based on September's average spread. That compares with 12% when the spread is at its long-run average. The odds rise to 50% when the curve is roughly flat or slightly inverted.
The curve has historically been an unusually strong predictor of recessions 12 to 24 months ahead. But it gave a false signal in 2022-24, when the economy avoided a downturn.
"The flattening yield curve is a warning that recession risk has increased, not evidence that a downturn is imminent," Dwor-Frecaut wrote.
Shorter-term indicators are mixed. Profit growth and new orders remain strong and jobless claims are low, but building permits are slowing.
Markets are pricing in three rate hikes by the end of 2027, compared with one in the Fed's median projection. Because Fed Chair Kevin Warsh gives no explicit forward guidance, Dwor-Frecaut warned that markets could read each hike as a sign of a steeper path than the Fed intends. That could tighten financial conditions too early and risk "inadvertently advancing the recession clock."
She expects one more hike in 2026 and then a hold through 2027.
(Karen Brettell)
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