2 yr - 10 yr Treasury: Why does this indicate a recession?

Fellow monkeys,

I currently work in brokerage where our financing professionals are constantly preaching about the spread between the 2 yr and 10 yr treasuries (and have been for some time now). I understand that the yield curve inverting is supposed to indicate a recession in the future, but I was hoping some of you could break down the "why"

Thanks Guys.

Comments (13)

Jan 3, 2019

because people are locking money up for a longer period of time for a lower yield, no liquidity premium.

This means they fear the short term, they fear there will be no good place to put their money in the short term so they are locking it away at a crappy rate because they think during that period, there will not be better alternatives.

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Jan 3, 2019

When the gettin's good, 10 Year yields should always be higher than shorter term yields because you lose out on liquidity, your money is locked away for a longer period of time.

Yields are compressing for the10 year because there is a higher demand for them right now, presumably because people are scared for what is to come in the short term and want to lock their money away to keep it safe.

Jan 3, 2019

Can any mortgage broker offer their two cents on the best gauge for commercial mortgages?

Is it the 10 year treasury or LIBOR?

Jan 3, 2019

I work for a direct lender that has a CMBS and a balance sheet product. We do typically 10 Year Treasury+swap for cmbs and 1 month libor for floating rate balance sheet.

Jan 3, 2019

Interesting. So fixed rate? Can you further explain how swaps work and how treasury relates toCMBS?

Isn't CMBS fixed rate? What happens when the 10 year moves up?

Jan 3, 2019

google, you're asking for detail that is tangential to the original thread, if it was directly related I would say go for it because people came to this thread to read it, but to ask a professional to take time to explain something you could google on an unrelated thread ....
Edit: sorry, bad day

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Most Helpful
Jan 3, 2019

Relax man. Don't be that guy on this forum. Damn. No one likes the "google it" guy.

I'd rather hear from an industry professional than google, hence why I'm asking.

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Jan 3, 2019

Aswath Damodaran released an interesting video a couple weeks ago about the predictive power of different parts of the yield curve inverting. The main takeaways were that there is no predictive quality to the 2yr and 10yr inverting, but there is some predictive qualities to the shortest maturities inverting.

I think of this in a very simple way. What are you getting compensated for as you get maturities that are farther out? Typically, when things are normal, you are being compensated for the higher possibility of things going wrong in the economy over a given 10 year period than a given 1 year period. If there is reason to believe that there will be greater risks in the very near term than over a longer period on average, then the curve can begin to invert.

Jan 4, 2019

It's important to note that money is fleeing shorter term treasuries to longer term ones, which puts upward pressure on short term bills and does the opposite to long term notes. You probably know this already, but the yields are directly related to demand and move inversely to the demand.

Jan 6, 2019

Recessions usually happen 1-2 years after the inversion. At my shop we've been thinking we're going to invert in Q1 of 2019, but its been looking more and more like it may push to Q2.

Jan 6, 2019

Yes we can look at these treasuries inverting as a sign of potential recession. But we have never been here before. Nobody really knows how the Feds unwinding of its balance sheet will effect anything and everything.

Jan 7, 2019

In traditional banking, banks borrow money from depositors (short term) and lend out longer term (mortgages typically repaid after 10 years). When the curve inverts, banks lose money doing this and therefore credit dries up.

There are also psychological aspects: lower rates for longer term debt means that the market is anticipating low rates in the future. And why would the market expect low rates in the future? Because there are many pre-recession indicators flashing and therefore the Fed is likely to go easy on future hikes. The 2/10 spread inverting doesn't predict recessions, rather the market predicts a recession and the 2/10 spread just shows you that's what the market is thinking...

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Jun 3, 2019