Latest / The Macro Memo with Fexingo: Daily Conversations on Inflation, GDP, and Federal Reserve Policy / The Uninversion That Changed the Yield Curve Story
Transcript
- Lucas: So the yield curve just uninverted. After two years and three months — the longest inversion since the 1970s — the 2-year Treasury yield is back below the 10-year. As of this morning, the 2-year is at 3.72 percent, the 10-year at 4.53 percent. That's about 80 basis points of positive slope. Luna: Which normally would be a big recession warning, right? The classic pattern is the curve inverts, then uninverts, and a recession follows within twelve to eighteen months. Lucas: Exactly. That's the textbook. 1990, 2001, 2008 — all had that pattern. But the reason I think this time might be different is what's actually driving the uninversion. Normally it happens because the Fed is cutting short-term rates aggressively, trying to stimulate an economy that's clearly weakening. This time, short-term rates haven't moved. The fed funds rate has been at 3.63 percent since December. The uninversion is happening because long-term rates are going up. Luna: Right, the 10-year yield has risen about 20 basis points just this week, and the 30-year is at 5.04 percent. That's the highest since 2007. So the bond market is not pricing in a recession — it's pricing in something else. Lucas: Yeah, the phrase you hear a lot is 'term premium.' For years after the financial crisis, the term premium was negative — investors were willing to accept lower long-term yields because they expected rates to stay low forever. That era is over. Now you're getting paid to take duration risk again. And that changes the whole calculus for mortgages, for corporate borrowing, for how the government funds itself. Luna: I want to stick with this because I think a lot of listeners hear 'yield curve uninversion' and immediately think recession. And you're saying — what exactly? That this time the signal is different because the mechanism is different? Lucas: That's exactly it. Look at the data we have. Real GDP growth came in at two point one percent for the first quarter — not booming, but not recessionary. The unemployment rate just ticked down to four point two percent. Jobless claims are still low at 215,000. This is not an economy that's flashing red. What the bond market seems to be saying is: the neutral rate of interest is higher than the Fed thought. And if that's true, then the Fed might not cut much even if growth slows a bit. Luna: You know, if this episode is making something click for you — maybe you've been reading about the yield curve for months and this is the first time the mechanism really lands — that's exactly the kind of thing that keeps us going. And it's also the kind of thing that stays ad-free because of listener support. If today was actually useful to you, buy me a coffee dot com slash fexingo. Seriously, that's how this works. No ads, just people who find it valuable chipping in. Lucas: It really does make a difference. And we mean it — we don't have sponsors, we don't have pre-rolls. It's just us and the data. So if you're getting something out of it, that link is the whole engine. Luna: Alright, back to the curve. So the term premium is back. What does that mean for, say, someone taking out a mortgage right now? Lucas: It means the 30-year fixed mortgage rate is going to stay elevated even if the Fed cuts. Because mortgage rates track the 10-year yield plus a spread. If the 10-year is at 4.53 and the term premium is maybe 50 basis points of that, then even if the Fed cuts short-term rates by 50 basis points, the 10-year might only fall to 4.3. Mortgage rates stay around 6.5 to 7 percent. That's a headwind for housing. Luna: And for corporate borrowing too. Companies that need to refinance debt issued at low rates in 2020 and 2021 are looking at significantly higher costs. I saw a stat that about two trillion dollars of investment-grade debt matures by the end of 2027. Lucas: Right. And that's where the recession risk could actually materialize — not from the yield curve signal itself, but from the higher cost of capital feeding through the economy. So the uninversion might not be a warning in the traditional sense, but it does tell us that the environment is fundamentally different from the last decade. We're not going back to zero rates. Luna: And if we look at the breakeven inflation rate — the 10-year breakeven is at 2.25 percent. That's pretty stable, right? So the bond market isn't panicking about inflation either. Lucas: No, it's not. Core PCE is running around 2.7 or so, but the breakeven says the market expects inflation to settle around 2.25 over the next decade. That's actually close to the Fed's target. So the rise in nominal yields is really a rise in real yields — the inflation component hasn't changed much. That's a term premium story, not an inflation scare. Luna: So to sum up where we are: the curve is uninverted, which in the past meant recession, but the underlying dynamics — rising long-term yields, stable inflation expectations, a decent economy — suggest this time is different. But maybe the risk is that the higher term premium itself slows things down enough to eventually cause a recession. Lucas: That's the tension. The bond market is effectively saying: we think the economy is strong enough that the Fed won't cut much, so we want more compensation for holding long-term bonds. But if that compensation stays high, it acts like a tightening of financial conditions. So the question is whether the economy can absorb it. The first quarter GDP number of two point one percent suggests it can, for now. But we'll see how the second quarter shapes up. Luna: And the yield curve itself — the spread between the 2-year and the 10-year — is now positive. Does that change any of the Fed's thinking? Do they look at that as a signal that policy is no longer restrictive? Lucas: I think they're more focused on actual activity data. The yield curve isn't a policy target. But it does feed into their overall assessment of financial conditions. A steeper curve can be a sign that the market expects future growth or future inflation, and that might make them cautious about cutting. Right now, the fed funds rate is 3.63, the 2-year is 3.72, the 10-year is 4.53 — that's a pretty normal upward-sloping curve. It's not signaling extreme tightness anymore. Luna: What about the 30-year bond at 5 percent? That's a big psychological level. Does that change anything for pension funds or insurance companies that have to match long liabilities? Lucas: It's actually good for them in some ways. Pension funds want higher yields to meet their return assumptions. A 5 percent 30-year bond means they can lock in a decent return without taking credit risk. But for the Treasury itself, it makes borrowing more expensive. The government is issuing a lot of debt — deficits are still large — and higher interest costs crowd out other spending. Luna: So the uninversion is really a story about the long end of the curve repricing, not about the Fed. And that repricing has implications for everyone — homeowners, companies, the government, and investors. Lucas: Exactly. I think the most important takeaway for listeners is: don't just see the yield curve as a recession indicator. See it as a price signal. Price tells you what the market expects. Right now, the market expects a world where rates stay higher for longer, and it's demanding more compensation for that uncertainty. Whether that becomes a self-fulfilling prophecy is the real story to watch over the next six months. Luna: And we'll be watching it. Thanks, Lucas. Lucas: Thanks, Luna. That's it for today's Macro Memo. We'll talk tomorrow.