The Federal Reserve's favorite recession indicator flashes again! Is the U.S. economy "flashing red"?

The Zhitong Finance APP has learned that typical recession warning signals are flashing in the U.S. Treasury market—the 10-year U.S. Treasury yield is lower than the 3-month U.S. Treasury yield, known as an inverted yield curve. Over the past few decades, this warning signal has a reliable record in predicting economic recessions (12-18 months after the signal appears).

In fact, the New York Federal Reserve considers this a very reliable indicator, updating this relationship monthly and providing the probability of an economic recession occurring within the next 12 months. At the end of January, when the 10-year U.S. Treasury yield was about 0.31 percentage points higher than the 3-month U.S. Treasury yield, the New York Fed's model showed that the likelihood of a U.S. economic recession in the next 12 months was only 23%. However, as the 10-year U.S. Treasury yield and the 3-month U.S. Treasury yield inverted, the probability of recession has indeed increased.

Joseph Brusuelas, Chief Economist at RSM, stated, "It is to be expected that investors may adopt a more risk-averse attitude out of panic over economic growth. This often occurs in the later stages of the business cycle." "It is still unclear whether this is more noise or a signal indicating that we will see a more significant slowdown in economic activity."

Although the market is more closely watching the relationship between the 10-year U.S. Treasury yield and the 2-year U.S. Treasury yield, the Federal Reserve prefers the measure of the difference between the 10-year U.S. Treasury yield and the 3-month U.S. Treasury yield, as the 3-month U.S. Treasury yield is more sensitive to changes in the federal funds rate.

However, the inversion of the 10-year-3-month U.S. Treasury yield curve has a reliable but not perfect predictive history. In fact, the last time this yield curve inverted was in October 2022, and the U.S. economy has not yet entered a recession two and a half years later. Therefore, the latest yield inversion does not necessarily mean that a recession will definitely occur. However, investors are concerned that the growth expectations brought about by President Trump's ambitious economic agenda may not be realized.

After the presidential election on November 5, 2024, the 10-year U.S. Treasury yield began to soar. This is usually a clear sign that investors expect the economy to grow further. However, some market professionals also point out that this indicates investor concerns about inflation and the demand for higher yields on government bonds amid worsening U.S. debt and deficit issues.

Since Trump took office, the 10-year U.S. Treasury yield has fallen significantly, down about 32 basis points to date. The reason is that investors are worried that Trump's tariff-focused trade agenda will drive up inflation and slow economic growth.

In addition to the warning signal of the inverted 10-year-3-month U.S. Treasury yield curve, a series of recently released data also shows signs of slowing economic growth. Data released on Tuesday showed that the U.S. Conference Board Consumer Confidence Index fell sharply to 98.3 in February, marking the largest decline since August 2021, far below economists' estimate of 102.5, and even lower than the most pessimistic forecast of 99.3Among them, the U.S. Conference Board Consumer Expectations Index fell sharply from 82.2 to 72.9 in February. A drop in the expectations index below 80 is typically seen as a signal of economic recession. This is the first time since June 2024 that the expectations index has fallen below the 80 threshold, which indicates a warning of economic recession, and it recorded the largest single-month decline since August 2021. Before the 2008 financial crisis, the expectations index continued to decline, providing an early warning of shrinking consumption and the risk of economic recession.

At the same time, data released last Friday showed that the one-year inflation expectations from the University of Michigan rose to 4.3% (up from the previous value of 3.3%), and the five-year inflation expectations from the University of Michigan in February rose to 3.5% (up from the previous value of 3.2%), reaching the highest level since 1995.

On one hand, there are concerns about economic recession, and on the other hand, there are worries about high inflation. This combination can be described as "economic poison"—the coexistence of recession warnings and rising inflation directly undermines the narrative foundation of the "perfect rate cut" by the Federal Reserve.

However, other indicators, including consumption and the labor market, still show resilience in the U.S. economy. In this regard, Tom Porcelli, Chief U.S. Analyst at PGIM Fixed Income, stated: "We do not expect a recession, but we do expect economic activity to be weaker in the coming year."

The market has also begun to agree with the view that U.S. economic activity will weaken. Traders have resumed bets this week that the Federal Reserve will cut rates twice this year and once next year to around 3.65%, indicating that traders believe the Fed will loosen monetary policy to support the economy as growth slows.

Chris Rupkey, Chief Economist at FWDBONDS, stated that the bond market has sensed "the smell of economic recession in the air." However, Chris Rupkey is also uncertain whether a recession will actually occur, as the labor market has not yet shown signs of an impending recession. He noted that the inverted yield curve is "purely because the economy is not as strong as people thought it was when the Trump administration came to power," adding, "I don't know if we are predicting a full-blown recession; a recession requires unemployment numbers (to prove it)."