Bad Tidings From the Bond Market

From a longer vantage, the August 2020 trough may just possibly have marked the end of a 40-year bull market in bonds. The rock-bottom 10-year yield that summer was the culmination of a decline from a peak of more than 15.8 percent in 1981. That peak occurred, not coincidentally, when Paul Volcker was the chairman of the Fed and the Consumer Price Index was rising at a 14.8 percent rate. After Mr. Volcker vanquished inflation, interest rates began their long descent. Now, along with inflation, they are rising, and that shift is hurting the price of a broad array of bonds.

The 10-year Treasury’s current level, above 2.4 percent, represents an enormous increase in yield since that nadir — and a nasty decline in bond prices — made all the more painful because much of it has occurred since the start of this calendar year, when the 10-year yield was just 1.51 percent.

What has happened since then? Briefly put, the Consumer Price Index reached a 7.9 percent annual rate, the unemployment rate dropped to 3.8 percent, and Russia invaded Ukraine, sending the prices of oil and other critically important commodities soaring. Faced with all this, at its last policymaking meeting, the Federal Reserve Open Market Committee began raising the federal funds rate and said it would keep doing so. Jerome H. Powell, the Fed chairman, has vowed with increasing urgency to do whatever it takes to bring inflation down to more modest levels.

Signals that may mean recession

The sharp rise in bond rates has produced some dislocations along the way, sending out signals that have, in the past, sometimes meant that a recession was on the horizon. They are worth monitoring closely, but the picture they give now is murky, at best.

First, some background: Bond rates are set by traders in the market, not by the Fed. Typically, when the economy is growing, investors receive a premium for lending money for longer periods. But sometimes short-term interest rates go higher than long-term rates.

When that happens, the bond market calls it a “yield curve inversion” and it implies, at the very least, that financial conditions are becoming tighter — and, possibly, that economic activity will slow so much that a recession is in the offing.

In the last few weeks, there have already been inversions of the yield curve, and more are likely. But what does it mean?