Ping An View:
On April 1, 2022, the difference between the yields of 10-year and 2-year US bonds was upside down, and the upside down range reached 5bp as of the closing of the day. Historically, the 10y-2y spread upside down often indicates that the U.S. economy will fall into recession after a period of time. Our research found that the inversion of 10y-2y interest rate spread is different from the past, which may weaken its ability to predict the recession.
Difference 1: during this upside down, the inflationary pressure in the United States was much higher than before, second only to the early 1980s. The intensification of inflationary pressure has given birth to some different phenomena: first, the trend of 10y-2y spread and 10y-3m spread is differentiated. While 10y-2y spread is upside down, 10y-3m spread is widening. Second, this upside down occurs at the initial stage of interest rate increase, and occurs when 10Y and 2Y interest rates rise at the same time.
Difference 2: This upside down occurred after the Federal Reserve significantly expanded its balance sheet and lowered long-term interest rates. Many studies have shown that the Fed's asset purchase has a direct impact on the long-end US bond yield, but has a limited impact on the short-end yield. Therefore, the Fed's implementation of QE directly lowers the term premium, and the US bond interest rate is more prone to upside down. If the impact of fed QE after covid-19 epidemic is excluded, the current 10y-2y spread is still far from upside down.
Difference 3: at the time of Fed tightening, the central banks of Europe and Japan have not withdrawn from monetary easing. The monetary policies of the central banks of other economies also have a spillover effect on the United States, which in turn affects the yield of long-term US bonds, producing an effect similar to QE. During the first two rounds of US bond yields upside down, the number of US bonds held by European and Japanese investors decreased. However, since the middle of 2021, the scale of US debt held by Japan, Germany, France and other countries has been increasing, indicating that the spillover effect of other central bank monetary policies on the United States is depressing the long-term yield of US debt.
This upside down has limited significance for judging whether the US economy is about to fall into recession: 1) compared with 10y-2y, 10y-3m interest rate spread with stronger ability to predict recession is still widening, which undoubtedly weakens the indicative role of 10y-2y interest rate spread upside down; 2) In the past, the time interval between upside down and recession was not stable, with an average of 16 months and a maximum of 24 months; 3) QE, QT and other unconventional monetary policy tools make the correlation between the term spread and the tightness of the financial environment more blurred, which weakens the upside down ability to predict the recession; 4) The Fed's policy may be adjusted in time to avoid the US economic recession and strive to achieve a "soft landing"; 5) From the perspective of economic recession and service recovery, there is still little room for the U.S. economy to recover in the short term.
Generally speaking, the short upside down of the 10y-2y US bond interest rate spread this time is mainly caused by two factors: first, the expectation of raising interest rates has risen rapidly under the background of high inflation, which has greatly boosted the yield of two-year US bonds; Second, after the sharp expansion of the balance sheet of the Federal Reserve and the European Central Bank, the yield of long-end US bonds was significantly depressed. However, the widening of 10y-3m interest rate spread with stronger ability to predict the recession, the US economy is still in the recovery stage, and the Federal Reserve's monetary policy may be adjusted according to the circumstances, all indicate that the upside down of 10y-2y interest rate spread has limited predictive effect on the impending recession of the US economy.
