One key recession indicator is flashing a warning signal to investors.
The yield curve has flattened to its lowest level since June 2007 with the 10-year Treasury note yield only around 10 basis points above the 2-year note.
Joseph LaVorgna, chief economist of the Americas at Natixis, says the move has him “very worried” about what comes next.
“The yield curve has almost always forecasted the direction of trend growth, meaning when the curve flattens, growth with a lag tends to slow and vice versa when the curve steepens,” LaVorgna told CNBC’s “Trading Nation” on Tuesday.
The yield curve inverts when shorter-term Treasurys yield more than longer-term Treasury yields. The relationship between the 2-year and 10-year yields is often used as a barometer of investor expectations for economic growth.
Still, while the flattening yield curve is cause for concern, it’s not yet time to panic, says LaVorgna.
“Typically the 2s/10s has roughly a 16-month lead from when it inverts to a recession and it could be even longer than that,” he said. “Much will depend on what the Fed does.”
The Federal Reserve’s rate moves tend to influence the short-end of the curve, including the 2-year Treasury yield, more quickly. Expectations of a hawkish Fed that hikes too aggressively could tip the short end of the curve higher than the long end.
“If the Fed relents later this month and takes off some of those dots, it takes away some of those aggressive rate-hike projections, the yield curve will then stop flattening, it might steepen out a bit, and that would be a sign the economy, at least in the markets’ mind, has some more room to run,” LaVorgna said.
The Fed is widely expected to raise interest rates at its meeting on Dec. 18-19. Fed members will also release their dot-plot projections, which could ease concerns over how aggressively the central bank will move next year.
“Nothing is preordained. The curve isn’t saying there’s a recession imminently. It says that one is going to happen at some point on the horizon. What the Fed does from here, though, will be central to whether those market fears are realized,” he said.