On September 5th, Finance Associated Press (Editor Xiaoxiang) reported that on Wednesday, the yield of the 2-year US Treasury bonds fell below the 10-year yield, marking the end of the inverted situation of the key US bond yield curve since last month's 'Black Monday' global market storm.

Compared to the 'hurried' market during the storm stage on August 5th, this time, the end of the inverted trend of the US bond yield curve undoubtedly appears more clear, as the steepening process of the curve continued into the early Asian session on Thursday, with the benchmark 10-year US Treasury yield still about 0.3 basis points higher than the 2-year bond yield.

It can be said that this basically indicates the end of the long-term abnormal inverted stage of the 2-year/10-year US Treasury bond yield curve since mid-2022.

According to industry statistics, the duration of this round of inverted yield curve for US Treasury bonds (from July 2022 to August 2024) has exceeded 780 days, making it the longest duration of inverted yield curve experience in history.

So, from the short-term end of the inversion on August 5th to the now almost confirmed end of the inversion, what has the market experienced? What guidance can this historically long period of inverted yield curve provide for the future financial markets and the US economy?

End of the inverted yield curve: Occurring after another round of poor performance in US data

Looking back at the two experiences of the end of the inverted trend in US bond yields last month and overnight, an indisputable common point is that both occurred after poor performance of important US economic data. The well-known trigger last month was the dismal performance of non-farm data, while this week, before the non-farm data was released, the US macroeconomic data has already suffered two blows successively.

Following Tuesday's ISM manufacturing data, the latest bad news on the US economic front came from the labor market on Wednesday. US job openings for July dropped to the lowest level since the beginning of 2021, while layoffs increased, consistent with other signs of slowing labor demand.

According to the job openings and labor turnover survey data released by the US Bureau of Labor Statistics on Wednesday, US job openings for July were revised down from the previous month's 7.91 million to 7.67 million, marking the second consecutive monthly decline and falling below the market expectation of 8.1 million. Although slowing job growth was expected, there are concerns that the labor market may be heading towards a collapse, not just a temporary adjustment under the pressure of the Fed's rate hikes to curb inflation.

Across Wall Street, economists and fund managers have been searching for economic data that could indicate signs of weakness that may force the Fed to start an aggressive rate-cutting cycle.

The decline in job openings seen in Wednesday's data clearly adds to the evidence of a recent softening in the labor market, which may cause concerns among Fed officials. Slowing job growth, rising unemployment, and increased difficulty for job seekers to find work also fuel speculation about a potential economic recession.

Earl Davis, Head of Fixed Income at BMO Global Asset Management, believes that the weakness in the labor market lowers the threshold for the Federal Reserve to cut rates by 50 basis points later this month. He pointed out that once the Fed starts cutting rates, it is unlikely to be a one-time move because they have enough room for rate cuts.

Market data shows a significant drop in the 2-year US Treasury yield on Wednesday, as the data revealed that US job openings in July hit the lowest level since the beginning of 2021, leading to an increase in rate cut expectations. Short-term bond yields are closely tied to the Fed's benchmark interest rate. The 2-year US Treasury yield briefly fell by 9 basis points to 3.768% by the end of the day, reflecting the market's higher expectations for a rate cut by the Fed on September 18, with more people predicting a cut of up to 50 basis points. The 10-year US Treasury yield, on the other hand, only dropped by 6 basis points to 3.768% on the same day.

Interest rate swap prices indicate that traders currently expect a 100% probability of a rate cut by the Fed this month, with a probability of a 50 basis point cut exceeding 40%. It is expected that the remaining three policy meetings this year will result in a total rate cut of at least 110 basis points.

John Fath, Managing Partner at BTG Pactual Asset Management US, said that if the Fed really cuts rates by a significant 50 basis points, the key 2-year/10-year US Treasury yield curve may finally cease to invert.

Interest rate cut is confirmed, so what about the recession?

Historically, the yield curve tends to slope upward as the maturity lengthens. Investors who deposit cash in longer-term government bonds often demand higher yields or returns. The reason for the inverted curve, essentially, is the result of traders pricing in a future economic slowdown.

In 2022, as the Fed launched its most aggressive tightening cycle in decades, the U.S. bond yield curve inverted. By March 2023, the 2-year U.S. Treasury notes yield at one point exceeded the 10-year yield by 111 basis points, marking the largest inversion since the early 1980s.

Typically, the key U.S. bond yield curve inversion has always been a precursor to an economic recession. In this type of inversion, longer-term yields are lower than short-term yields, often seen as a harbinger of an economic recession in the next 18 months to two years—of course, the duration of this inversion has actually been longer than in the past.

The point at which the yield curve inverts until the economic recession occurs has always been a very sensitive time.

After a prolonged inversion, the yield curve returning to a normal upward slope generally occurs when the Fed begins to cut interest rates. And because the Fed often tends to ease policy only when the economy encounters difficulties, this reversal will exacerbate investors' concerns about an economic recession.

Quincy Krosby, Chief Global Strategist at lpl financial, stated that statistically, the normalization of the U.S. bond yield curve—ending the inversion—is either due to the actual economic recession, or because the Fed is about to cut rates to address the economic slowdown.

This can actually be clearly seen from the chart below (the red shaded part corresponds to the economic recession period):

The President of The Baker Group, Ryan Hayhurst, said, 'I like to say that once the yield curve turns positive, it often means the beginning of an economic recession.'

Of course, considering that the inversion of the US Treasury yield curve has lasted for more than two years, but the recession has not yet occurred. At the same time, many industry insiders have previously questioned whether the epidemic factor has caused a series of distortions in US economic warning indicators. Therefore, the end of this curve inversion does not necessarily indicate that a recession is imminent, and it is still not a sure thing.

Jerome Schneider, Head of Short-Term Portfolio Management and Funding at PIMCO, said, 'This is probably a healthy thing at the moment, and we should cheer for it. A normal yield curve shape indicates a more normal and balanced business and monetary policy environment.'

Priya Misra, Portfolio Manager at JPMorgan Asset Management, also believes that the inversion of the yield curve is significant on the eve of the Fed's interest rate cuts. She added that the degree of market pricing easing is consistent with the Fed's expectation of interest rate normalization in order to maintain the current soft landing of the economy.

So, what guidance does the end of the recent yield curve inversions provide for the US stock market, the US labor market, and the Fed's interest rates? In the early morning of today Beijing time, Nick Timiraos, a well-known journalist known as the 'New Fed Communications Agency', listed the experiences before and after the end of the three recent inversions (except for the epidemic in 2020), which investors can refer to.

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Editor/Somer