Bond market flashes yield curve warning

Bond market flashes yield curve warning

The dollar stumbled last week after Federal Reserve Chairman Jerome Powell on Wednesday said US rates were nearing neutral levels, which markets interpreted as signaling a slowdown in rate hikes.

Giddis added that with all eyes on inflation, the Labor Department's report on the employment situation on Friday will be key for Fed officials. Karl W. Smith suggests the market is pricing in lower Fed rates in the future, either to end a recession or to prevent one.

"This solidifies not only my flattening bias but I think it will lead many players in the market who [expected the yield curve to steepen] to capitulate on that", Ian Lyngen, head of united rates strategy at BMO Capital Markets, told CNBC.

- CNBC's Sam Meredith and Ryan Browne contributed to this article.

Such an inversion of two-year and 10-year yields, when 10-year bonds yield less than their two-year debt, has preceded every US recession in the past 50 years. By Tuesday afternoon, the five-year yield was at 2.78 percent, 0.01 percentage points lower than a two-year Treasury and 0.02 points lower than a three-year Treasury.

The MSCI's all-country index shed 0.5 percent.

Global equities have been shaken by fears of a recession, fanned by the flattening U.S. Treasury yield curve - a phenomenon in which longer-dated debt yields fall faster than their shorter-dated counterparts.

However, despite its track record, many economists question the reliability of the yield curve for predicting recessions, including Powell.

"We should be data dependent but not reacting to every wavering of the needle across the dial..."

Whatever the situation with the Fed and the USA markets, emerging markets may be effected even more than the US economy.

Traders are even starting to bet that the Fed will cut interest rates as soon as 2020.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either.

What exactly is a yield curve, and why is it inverting?

But since then, it has persistently declined, especially since the middle of last week, and now is at its narrowest since July 2007, on the eve of a steep recession.

The term premium refers to the higher interest rate investors typically demand to commit money for longer periods of time. An inversion of the two-year and 10-year yields has preceded each USA recession in the past 50 years.

Markets are also bracing for more news on Brexit.

German 10-year yields are also being pushed down by domestic concerns, Commerzbank's Rieger said, with European growth indicators sagging and Italian political concerns rumbling on in the background.

The outlook for US growth, by contrast, he said remained strong. In recent weeks expectations about what the Fed will do next year have eroded, with investors now anticipating policymakers will raise rates only one time next year, and, coupled with an expected increase in December, pause with a federal funds rate of around 2.7 percent.