> May still hold true, the 2s10s has recently deinverted, which is typically the last stage pre-recession.
For those of us not in the know, could you give some more detail? What is 2s10s, what does it mean that it's deinverted, and why is that typically the last stage pre-recession?
Normally long-term bonds have higher interest rates than short-term bonds, because investors need to be paid more money to take the risk of locking up their money for longer time period. The exception is that when you expect interest rates to fall in the near future, it makes more sense to hold long-term bonds, because you lock in today's rates for a longer time period, while the investor that picks up 2 year bonds will have to roll them over at whatever they can get in two years. That bids up the price of long-term bonds, which makes the effective interest rate fall. This situation is called an "inverted" yield curve, because it is the opposite of the normal situation.
A "deinverted" yield curve is when you have an inverted yield curve but the difference suddenly goes positive again. That's the situation we're in now, as you can see from the graph. And usually you get into that situation because the scenario investors feared actually happens: short-term interest rates drop, partially as a response from the Fed to inject more money into the economy and stave off the recession, and partially because stocks become very risky in a recession and so investors flee them and go to short-term bonds instead to preserve capital.
The deinverting isn’t so much due to the Fed injecting money as it is an anticipation the Fed will inject money by cutting rates in the coming future. The 2 year yield drops in anticipation of the Fed dropping interest rates in the next couple years. That’s what makes it a leading indicator.
It's one of the most popular predictors of the scary scary recession. In short, borrowing money for longer periods of time should cost more than borrowing money for shorter periods of time (even if you normalize both values to percent per year). There is also an explanation that is more mechanistic and related to central bank activities. However, sometimes the opposite is true, and that is the "inversion". Here's a nice explainer from the FT:
BTW, there is something very similar in commodities markets - contango and backwardation. Contango comes from some old British word that's similar to "continuation" and describes the usual situation for non-perishable goods where if you, a buyer, want to delay the delivery of goods then I, the supplier, will charge you a little extra for using my storage space. This little extra is called "continuation fee", or "contango". It shows up in modern commodity markets like the CME on price vs time-of-delivery curves. But sometimes the markets are in backwardation and earlier deliveries are more expensive than late deliveries.
PS. "2s" meaning "the twos", meaning "two-year Treasury bonds"; it's a common abbreviation.
But to be a little pedantic, the 2-year and 10-year issues are Treasury Notes, not bonds. I don’t know why they use 3 different terms depending on the duration, but they do.
So the difference in 2 year vs 10 year treasury bonds. If they are not trending in the same direction, the near term thinking is that the market is doing poorly.
For those of us not in the know, could you give some more detail? What is 2s10s, what does it mean that it's deinverted, and why is that typically the last stage pre-recession?