The spread between 10-year treasuries and 2-year treasuries briefly uninverted above 0 this morning on Aug. 5 for the first time since July 2022, when it fully inverted in the wake of the sticky inflation which peaked at 9.1 percent in June 2022. It quickly reinverted itself and stands at just -0.1 percent as of this writing.
Fully inversions like that tend to predict a recession on the horizon. Now, with the unemployment rate up to 4.3 percent in July from its 3.4 percent low in April 2023 and the Federal Reserve signaling it is nearly ready to begin cutting interest rates—it usually does that when a recession is closing in—a slowdown or downturn appears imminent.
And stock markets appear to be agree, with major indices taking big hits in just the past two trading days.
As for the 10-year, 2-year spread, when it inverts, that means short-term interest rates were higher than long-term interest rates. This happens when traders buy more long-term bonds than short-term bonds, likely on the expectation that interest rates — and therefore growth — will be lower looking forward.
Now the situation is beginning to reverse as the lower interest rates are kicking in, anticipating the Fed cutting interest rates moving forward. That usually happens about 6 to 12 months before recessions are typically booked, just looking at the effective Federal Funds Rate over modern history.
So, what does this likely mean? As investors shift in treasuries purchases—an attempt to lock in the highest possible interest rate in the near term—demand for treasuries increases and so interest rates drop. As capital shifts out of equities—markets appear to be rapidly crashing on the unemployment news—this means firms will have less on hand to hire new people.
Additionally, unemployment continued claims are up a full 746,000 since their low in Oct. 2022 to 1.945 million as of July 6, according to Department of Labor statistics. But overall unemployment is up 1.47 million since its Dec. 2022 low of 5.7 million. That indicates half of the people who lost their jobs have already run out of unemployment benefits.
And with the yield curve finally beginning to normalize itself, that usually predicts more unemployment on the horizon as the air comes out of the economy.
Politically, that is all undoubtedly terrible news for Vice President Kamala Harris who is now squaring off against former President Donald Trump in the 2024 election after President Joe Biden stood aside for the Democratic Party’s nomination this year.
Usually, when there’s high inflation followed by rising unemployment, the incumbent party, in this case the Democrats, pays the price at the polls, with the most recent political victims being Gerald Ford, Jimmy Carter and George H.W. Bush. Donald Trump also lost his job in 2020, when although there was not high inflation, there was the Covid recession and 25 million jobs temporarily being lost.
There are exceptions, for example, Ronald Reagan experienced high inflation followed by a bad recession in 1981 and 1982 and rise in unemployment that peaked at 10.8 percent Dec. 1982. But by the time he was running for reelection, unemployment was already down to 7.4 percent and millions of jobs were being created. Reagan went on to win in a landslide.
Whereas in the Biden-Harris economy, unemployment is still rising during the election year. In 1960 and 1980, when recessions struck during election years, the incumbent party definitely paid the price. Whether and how that impacts Harris in her own election bid remains to be seen, but it probably doesn’t help. Stay tuned.
Robert Romano is the Vice President of Public Policy at Americans for Limited Government Foundation.
