First time in two years! 2-year/10-year US Treasury yield curve turns positive, market bets on the Fed cutting rates by nearly 120 basis points this year

According to Zhitong Finance, the yield on the 2-year US Treasury bond has fallen below the 10-year Treasury bond yield for the first time since July 2022. This is due to concerns about an economic recession leading traders to bet that the Federal Reserve will significantly loosen monetary policy, thereby lowering the policy-sensitive short-term yield. On Monday, the 2-year US Treasury bond yield fell by 23 basis points to 3.65%, while the 10-year US Treasury bond yield was at 3.68%. In comparison, in March 2023, the 2-year US Treasury bond yield was 111 basis points higher than the 10-year Treasury bond yield, marking the deepest inversion since the early 1980s.

This is an important milestone for the US Treasury market. For most of the time since the Federal Reserve began raising interest rates 11 times (totaling over 5 percentage points) in March 2022, the short-term yield of US Treasury bonds has been higher than the long-term yield, resulting in an inverted yield curve.

Last Friday, the US Department of Labor reported that non-farm payrolls only increased by 114,000 in July, well below economists' expectations, and the unemployment rate unexpectedly rose to 4.3%. The Sam rule was triggered again - when the three-month moving average of the US unemployment rate rises by 0.5 percentage points or more from the low point of the past 12 months, it usually signals that the US has entered the early stages of an economic recession.

Meanwhile, the unexpected sharp drop in the ISM PMI released earlier last week also fueled recession trades. The July US manufacturing PMI fell to 46.8, below the expected 49 and June's 48.5. In addition, weaker-than-expected growth in US durable goods orders and wholesale inventories in June, as well as higher-than-expected initial jobless claims, have also exacerbated recession concerns.

Following a series of weak economic data recently, bond traders are very concerned about the US economy, and they are now considering whether the Federal Reserve will take emergency rate cuts to prevent an economic downturn. After a string of weak US economic data, market expectations for a Fed rate cut have increased. Following the data release, the CME FedWatch Tool shows that traders currently believe there is a 98.5% probability of a 50 basis point rate cut by the Fed in September, far higher than the 31% before the data was released. Traders have fully priced in expectations of at least a 25 basis point rate cut in September, with a cumulative cut of around 120 basis points expected by the end of the year.

Investors are betting that the Federal Reserve and other central banks will be more proactive in cutting rates, as concerns about the pace of US economic growth slowing down faster than expected a few weeks ago are increasing. This has fueled one of the strongest rebounds in the bond market since the US banking crisis erupted in March 2023 Marlborough Investment Management portfolio manager James Athey said that the inversion of the yield curve may indicate that the US economy has entered a recession. Athey stated, "History tells us that when the curve returns to a positive slope, you are already in a recession. During this period, the signal has become increasingly worrisome."