Dollar weak as U.S. Treasury yield curve inversion sparks recession fears

The Flattening Yield Curve Just Produced Its First InversionsMore

In fact, one section of the yield curve has already inverted: between 3-year and 5-year notes.

"Investors are coming around to our downbeat view of the prospects for the USA economy", analysts at Capital Economics wrote on Tuesday, arguing that there was no reason to regard this pending yield curve inversion as different from others.

The dollar, which started the week on a weak footing as a thaw in trade tensions between Washington and Beijing sapped demand for the safe-haven greenback, extended its fall as investors fretted about an inversion of the short end of the USA yield curve in bond markets. It has sometimes taken more than a year for a recession to occur after the yield curve inverts.

"Inversion of that curve is the real recession red flag", said Neil Wilson, the chief market analyst at Markets.com.

The 3-month to 10-year spread is now 0.492 percentage points.

Short-term rates traditionally move in tandem with changes in the Federal Reserve's overnight lending rate, the Federal funds rate.

"The U.S. economy is likely to be able to withstand another rate hike or two, therefore, the flattening of the Treasury curve looks a little over done".

What is a yield curve?

The Fed's target inflation indicator has held stable right around the two percent target, while the recent plunge in oil prices by more than 30 percent has eased fears of spiraling price increases.

Gundlach said the Fed will need to be especially careful in its choice of words when they meet this month to deliver on their promised rate hike.

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

On Monday, stock markets around the world got some relief after Washington and Beijing agreed to temporarily end their trade war during talks at the G20 summit in Argentina.

The moves follow similar declines in US bank shares, which dropped 4.4 per cent on Tuesday.

When yields for short-term Treasurys rise above yields for long-term ones, market watchers call it an "inverted yield curve", and Wall Street starts getting more nervous.

The yield curve inverted between the 2- and 10-year yield before the recessions of 1981, 1991, 2000 and 2008.

"A lot of it is momentum", said John Canavan, market strategist with Stone & McCarthy Research Associates in NY.

A typical yield curve includes much higher interest rates for maturities further into the future. Late in the day, the two-year yield also dropped below the five-year's, with the gap at negative 0.5 basis point heading into the evening.

This has set off a debate among bond investors as to the meaning of the inversion, with one camp arguing it is mainly symbolic while others claiming it indicates a recession is near.

While Fed officials have begun pointing to "headwinds" from slowing global growth and other risks, it won't be clear how much this has changed their outlook until they issue fresh economic projections after the December 18-19 policy meeting.

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