The Big Picture
There is a famous scene in the first Top Gun movie where Maverick inverts his F-14 and gives a friendly greeting to the pilot of the Russian MiG about two meters below. That inversion -- and that greeting -- were declarations of victory over the enemy, who knew it was time to bug out and head for home.
If life could imitate art in the Treasury market, there would be a lot of victory signs because there are inversions all along the curve.
Yield Signs
The 1-yr T-bill (4.93%) yields more than the 2-yr note (4.50%); the 2-yr note yields more than the 3-yr note (4.18%); the 3-yr note yields more than the 5-yr note (3.91%); the 5-yr note yields more than the 7-yr note (3.85%); and the 7-yr note yields more than the 10-yr note (3.73%).
For good measure -- and arguably the most telltale measure for presaging a recession -- the 3-mo T-bill (4.74%) yields more -- a lot more -- than the 10-yr note (3.73%). This spread is followed closely by the Fed, which knows it has inverted ahead of prior recessions. Research done by the New York Fed has indicated as much.
The 3mo10yr spread is also looked at closely by the market, which knows its predictive power for the U.S. economy. This spread is not only piquing recession concerns, it is also giving way to criticism that the Fed is going to overtighten and induce a hard landing for the U.S. economy.
Or will it?
Don't Believe the Hype
There is no question that the financial crisis and global pandemic led to the hardest of landings for the U.S. economy. Naturally, high-yield spreads widened considerably during those periods. They did as well during the 2001 recession, although the path to the peak spread then had less economic panic in it.
We'd say that is very much the case today as well, as seen in the chart below. The high yield option-adjusted spread sits at 4.05%. That is up noticeably from the lows seen at the start of 2022 (3.05%), but it is still a long way from conveying fear about a hard landing.
Moreover, it is a considerable improvement from where things stood last July (5.99%), when the target range for the fed funds rate was 300 basis points lower (1.50-1.75%) than it is today (4.50-4.75%). At 4.05%, the high yield option-adjusted spread is effectively the same as it was in February 2020 before COVID turned the world upside down and the global economy crashed.
Things can change in a hurry, which the chart below also shows, but it is fair to say at this point that the high yield option-adjusted spread is not corroborating the recession hype that the deeply inverted yield curve is.
What It All Means
Time will be the ultimate tell in terms of how the U.S. economy evolves. It had a pretty solid fourth quarter with real GDP up 2.9% at an annualized rate. The Atlanta Fed's GDPNow model estimate for real GDP growth in the first quarter is 2.2%, or a bit below the 2.6% quarterly average for 2019 when no one was talking about a hard landing.
The inversions along the Treasury yield curve aren't giving a friendly economic signal. Then again, the high yield option-adjusted spread isn't exactly bugging out.
The mixed signaling speaks to the divided views about the degree of softness the U.S. economy will face. To be sure, it is a dogfight that is apt to keep investors on edge and the market trading in a fitful manner.
