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Yield Curve Signals U.S. Recession On the Horizon

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J.D. DURKIN: You noted that the gap between the ten and the two year are signaling a bit of a recession. Can you explain this data point to people who have only a loose familiarity with, and why this particular data point, Martin, is so closely watched?

MARTIN BACCARDAX: It's very closely watched. It's one of the most accurate, although certainly not foolproof, recession indicators. It's basically described as the inverted yield curve. When you look at the rate of interest that U.S. Treasury bonds are paying out, you focus on the two year note and the ten year note. When the rate that is being paid out on two year notes is higher than that of ten year notes, that's called an inverted yield curve. Essentially, in a normal situation, the two year note should be lower than the ten. When the two year note is higher than the ten, again, it's called an inverted yield curve. And in many instances, it has preceded an inflation excuse me, a recession in the U.S. economy. And indeed every US recession since the Second World War has been preceded by an inversion of that yield curve.

More significantly, J.D., what we're seeing at present is that the yield on one month Treasury bills is now higher than the yield on 30 year bonds. That's only happened twice in the last three years and about four times in the last 20 years. Each and every time it's happened, there's been a recession within six months. That tends to be the most significant predictor of recession. So the bond market is absolutely telling us, that's where we're going to go. And they have been right many times in the past. So I think that's a bigger part of the reason why we're seeing that pullback in the dollar as well, because the assumption is that if the Fed does see the economy tip into recession, it will have no choice but to pull back expectations of future rate hikes.

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