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Recession Watchers May Be Looking in the Wrong Place

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Recession Watchers May Be Looking in the Wrong Place

The Bond Market Forecasts Trouble, But Not Where Many Think

When I recently Googled the phrase “10-2 Spread,” about 30 million results came up.  By way of comparison, that’s just a little less than when I Googled “Warren Buffett.”  So apparently the 10-2 Spread is somewhat of a “thing” these days.  After all, Wall Street pundits often point out that when the yield on U.S. Treasury securities maturing in 2 years exceeds the yield on those maturing in 10 years, a recession is typically not far behind.

The technical term for that by bond pros is that the “10-2 spread” has gone negative.  In English, it means that even though you can get your money back in 2 years on a bond, you can earn an annual return that is higher than if you locked it up for 10 years.  That is not very logical, and that’s why when it occurs, it often portrays a quirk in the markets.  This is also referred to as an “inverted yield curve”…but apparently not as often, as Googling that phrase only produced about half of the results that 10-2 Spread did.

Related: Is A Recession Looming? The Answer Is Still Yes

I am glad to report that I have been talking about the growing concern investors would have about the 10-2 Spread inverting for more than a year before it became a popular topic of conversation.  And while that indicator of future recessions has not yet gone negative, and has even shown signs of reversing from near the zero level (it was 0.23% as of 4/26/19), with the herd fixating on it the past couple of months, I started to look elsewhere for recession warning signs.  I found one.

As it turns out, you don’t have to look at the 2-year Treasury to get a “beware of recession” signal.  You need only go out to the U.S. Treasury Bills that mature in 6 months.  As shown above, the spread between the 10 year and 6 month Treasuries has a darn good record of telling us when cautious investment approaches are to be considered.

Recessions since the 1960s are shaded in grey, and the two maturity levels are graphed on top of each other.  When the orange line rises about the blue line, that’s the warning sign.  As you can see, it happened right before every one of the last seven recessions…every darn one!

As you can see, this alternate Treasury yield spread indicator I am citing is currently at about 0.14% (lower portion of the chart).  That is about the same level it sat at in June of 2007, and March of 2000, neither of which was a time to take one’s eye off the investing ball.  I am strongly suggesting that all investors balance the continued opportunity for reward in a market at record highs, with the lessons of history.

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