The Treasury yield curve has been mostly inverted for several months.
10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity (T10Y3M) is deeply negative, the lowest it has been since the 2000 dot-com bubble burst.
This is a clear indication of an approaching recession.
All METARs know that the Federal Reserve has been manipulating Treasury yields for years by buying massive amounts of Treasuries (up to 40% of the 10YT at some auctions). The Fed also buys TIPS. As the 10YT yield was suppressed, the Fed suppressed the TIPS yields at the same time to maintain a 10-Year Breakeven Inflation Rate of 2.0 to 2.5%.
When the Fed suppressed the 10YT yield to close to zero they also suppressed the 10Y TIPS yield to negative to maintain this constant gap. The 10Y TIPS yield was negative in 2012-2013 and also in 2020 to April 2022.
When the Fed started reducing its bloated book of long-term Treasuries by roll-off, long-term Treasury yields started rising in 2022. Longer-term bond yields have been falling since early November, a sign that the bond market believes that the Fed will be able to control inflation in the medium to long term.
Investors in long-term bonds need to consider the impact of inflation. The Fed (and the market) were blindsided by inflation. The real yield of $Trillions of bonds is now negative – and will stay negative until the Fed reduces inflation to their target of 2%.
TIPS investors are compensated for rising inflation since the principal of the bond is increased along with the CPI. An investor who buys a secondary market TIPS will pay more than par since they are paying the previous owner for the inflation increase of the bond’s value.
The TIPS yield curve shows the market’s expectation of future yields. The TIPS yield curve is fully inverted.
5-month TIPS are yielding over 3% (plus inflation). 3-year TIPS and later are yielding 1.5% and less. This is a pretty good yield for TIPS which hasn’t been seen since 2010.
It’s normal for long-term bonds to have an inverted yield curve during recessions. That’s why bond traders like recessions, because the value of their bond holdings increase when bond yields fall.
I think that inflation may turn out to be harder to control than the bond market has priced in. I also think that the Fed may return to suppressing long-term bond rates as it has before (QE) if the coming recession turns out to be more severe than they can accept. (Fed Chair Powell has said to expect some pain, but he wasn’t controlling the Fed during the nasty recession of 1980-1982 which had high unemployment that lasted a long time).
I think there is a real possibility of 1970s style stagflation. There have already been labor strikes which led to substantial pay raises.
For this reason, I just bought TIPS maturing in 2029 yielding 1.5% (plus inflation). Even if inflation does return to 2% (which I don’t think will happen fast) that would compare with a Treasury yield of 3.5% which is higher than it has had for 10 years (except for the spike over 4% in October 2022).