The Treasury yield curve just inverted, sounding the alarm for recession

The bond market is beginning to sound the alarm of a recession, with an inversion in U.S. Treasury yields occurring on Monday for the first time since 2007.

The yield on the 5-year Treasury note fell below the yield on the 3-year note, meaning that investors were being paid more to hold U.S. government debt maturing in three years than comparable bonds maturing in five years. It’s not the major curve inversion that investors watch for — the 2-year note holding a higher yield than the 10-year note, which has preceded every U.S. recession since World War II — but it portends that the market is headed in that direction, analysts told Yahoo Finance.

Ian Lyngen, head of united rates strategy at BMO Capital Markets, said the inversion of 3- and 5-year yields has strengthened his belief that an inversion of the 2-year and 10-year yield will happen in late 2018 or early 2019.

RELATED: Take a look at market closures in for funeral of former President Bush: 

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Market closures Wednesday in day of mourning for former President George H. W. Bush
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Market closures Wednesday in day of mourning for former President George H. W. Bush

STOCKS

The New York Stock Exchange and Nasdaq will be closed.

(REUTERS/Brendan McDermid)

BONDS

The Securities Industry and Financial Markets Association (SIFMA) recommended on Saturday that fixed-income cash markets close.

U.S. FINANCIAL FUTURES/OPTIONS

CME Group announced on Sunday that U.S.-based equity and interest rate futures and options products would be closed for trading.

(REUTERS/Brendan McDermid)

FEDERAL RESERVE BANK OF NEW YORK

The Open Market Trading Desk at the Federal Reserve Bank of New York said that reverse repurchase agreements and securities lending trades executed on Tuesday will mature on Thursday rather than Wednesday, given SIFMA's recommendation that fixed-income markets close.

(REUTERS/Eduardo Munoz)

ECONOMIC DATA

IHS Markit announced that the release of U.S. services and global services purchasing manager index data will be postponed to Thursday.

ADP said on Monday that it had rescheduled the release of its national employment, small business, and national franchises reports for Thursday at 8:15 a.m. EST (1315 GMT).

The U.S. Commerce Department has postponed the release of its quarterly services survey to Thursday at 10 a.m. EST.

The U.S. Labor Department will release nonfarm productivity and costs data on Thursday at 8:30 a.m. EST.

The U.S. Energy Information Administration has postponed the release of its weekly petroleum status report to Thursday at 11 a.m. EST and rescheduled its weekly natural gas storage report for Friday at 10:30 a.m. EST.

SECURITIES AND EXCHANGE COMMISSION

The U.S. Securities and Exchange Commission has canceled an open meeting scheduled for Wednesday at which it was due to discuss potentially issuing a consultation on changing quarterly reporting obligations.

(AP Andrew Harnik)

U.S. FEDERAL RESERVE

Federal Reserve Board offices will be closed on Wednesday.

Fed Chairman Jerome Powell's testimony to Congress' Joint Economic Committee on Wednesday has been postponed and will be rescheduled at a later date, the committee said on Monday.

(AP Photo/Cliff Owen)

CORPORATE EARNINGS

Lululemon Athletica Inc postponed the release of its third-quarter financial results to after the market close on Thursday.

American Eagle Outfitters Inc will now report its third-quarter financial results on Dec. 11.

H&R Block Inc will report results for the second quarter of the fiscal 2019 year before the market open on Thursday.

(AP Photo/Steven Senne)

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“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,” Lyngen said.

U.S. Treasury yields rose early on Monday after a deal between the U.S. and China to hold off on new tariffs. Shorter-dated yields rose faster than longer-dated yields, pushing the curve to invert between the 3- and 5-year yield.

The yield curve inverted between the 2- and 10-year yield before the recessions of 1981, 1991, 2000 and 2008. It has preceded all nine U.S. recessions since 1955, with a lag time ranging from six months to two years.

Analysts have pointed out that although many associate a yield curve inversion with recession, the phenomenon is a reflection of the kind of economic conditions that predict a market bust rather than being the cause of them.

An inverted yield curve is a sign investors think the government is less likely to pay back debt it owes in two years than what it owes in a decade — or in this case, the government is less likely to pay in three years than it is in five. Market analysts have pointed to everything from the increase in U.S. debt to cyclical factors like the market running out of steam as reasons for a downturn.

The combination of higher bond yields and the looming threat of recession is adding to fears about slowing global growth, investors said. It could also have implications for the Federal Reserve’s interest rate policy.

Fed Chair Jerome Powell said in a speech last week that U.S. interest rates were now “just below” the level that could be considered neutral and signaled that the Fed would stop raising rates. Investors viewed that as a stark turnaround from his remarks in October that the central bank was “a long way from neutral.”

Cameron Crise, macro strategist at Bloomberg LP, called the inversion “potentially the first shoe to drop in the end of the rate cycle.”

“Mind you, there can be a long delay between the first inversion of the  curve and subsequent rate cuts, as the last cycle showed,” Crise said in a report for Bloomberg. “Still, it’s more evidence that we’re in the ‘late 2005’ analogue of the current Fed campaign.”

Fed officials have not spoken much about the possibility of a yield curve inversion, but earlier this year a number of members of the Fed’s rate-setting committee said it was a development they were watching.

“One of the most pervasive relationships in macroeconomics is that between the term spread — the difference between long-term and short-term interest rates — and future economic activity,” the San Francisco Fed’s Michael D. Bauer and Thomas M. Mertens wrote in March.

Atlanta Fed President Raphael Bostic even said in May that it was his job to prevent the curve from inverting, joining a number of other U.S. central bank bosses who had openly voiced concern about inversion.

Dion Rabouin is a global markets reporter for Yahoo Finance. Follow him on Twitter: @DionRabouin.

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