An inverted Treasury yield curve is no longer a reliable signal of recession, and what matters more is the level of the curve, Bank of America (NYSE:BAC) economists said in a note Friday.
The Fed is flirting with inversion probably because policy makers recognize its waning predictive power in a low-yield global environment, the economists said.
A widely-watched part of the curve inverted on 22 March for the 1st time since the financial crisis when a surge of bond buying, driven by lower growth projections and the prospect of Fed easing, upended the gap between 3-mo Bills, and the benchmark 10-yr T-Note yields.
Meanwhile, the spread between 2-yr and 10-yr yields has stayed near some of the flattest levels in more than 10 yrs since December.
In fact, the Fed has the power to “prevent or quickly undo” an unwanted inversion, the BofA economists said. With central banks operating on both ends of the curve, “the level of the curve matters more than the slope,” they said.
The Fed “is not sleep-walking over a cliff” and “has concluded that an inverted curve is not what it used to be and never was the sole relevant financial indicator,” the bank’s economists wrote.
The 2-yr to 10-yr spread has inverted before each of the past 5 recessions, except for 1 false signal in Y 1998. The curve typically turns negative late in the business cycle when policy makers have overshot the neutral policy rate to slow above-target inflation.
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