The spread between 10-year and 3-month Treasury yields has dipped to approximately 153 basis points below zero, signifying an impending “deep recession,” according to Duke University professor Campbell Harvey. This inversion is more significant than the one preceding the 2007-2008 financial crisis and the late 1980s, when the Federal Reserve increased interest rates above 8% to 9%.
Recent data has raised concerns about the labor market’s vulnerability to the Federal Reserve’s ongoing rate-hike cycle. Market volatility, liquidity issues, and potential US debt-ceiling crises are causing additional uncertainty in the Treasury market. Harvey’s research on interest-rate structures and economic growth suggests a strong correlation between the magnitude of inversion and a substantial economic slowdown.
Though the 10-year/3-month spread usually provides a 6-18 month warning before a recession, Harvey initially believed a soft landing was more probable. However, following the Federal Reserve’s rate hikes in February and March, he now believes that policymakers have overreached and are “playing with fire.”
The inverted yield curve impacts banks by disrupting their business model, which relies on lending at higher long-term rates than the interest they pay depositors. The curve’s inversion has already contributed to the collapse of California’s Silicon Valley Bank, and Harvey questions how many other banks are at risk.