The bond market is about to do something noteworthy while everyone's distracted by Nvidia

While traders were focusing on Nvidia's results Thursday , something big was happening in the bond market. The inverted spread between the 2- and 10-year Treasury yields, considered a classic recession indicator, is nearly back to normal. In Thursday trading, the 10-year yield was less than 2 basis points below the 2-year rate , narrowing an inversion that began in June 2022. An inverted curve has been the harbinger of most every recession in the U.S.

Traders work on the floor at the New York Stock Exchange in New York City, U.S., August 28, 2024., narrowing an inversion that began in June 2022. An inverted curve has been the harbinger of most every recession in the U.S. since World War II, as it indicates that traders see growth over the longer term slowing. While a recession has yet to occur, the end of the inversion does not necessarily mean we are out of the woods yet.

In fact, the yield curve generally does normalize just before heading into recessions as traders begin to price in the likelihood that the Federal Reserve will have to start lowering interest rates as way to battle the economic slowdown.While markets most closely watch the relationship between the 2- and 10-year yields, the Fed keeps its eye on the 10-year compared to the 3-month Treasury.

However, Colas also pointed out that recessions generally need some unusual event, such as an oil price spike or financial crisis. Absent a crisis, there has been no recession. "This does not let the Fed off the hook with respect to cutting rates over the next 12 months, however, and markets know it," he added. "While it may seem aggressive for Futures to expect the Fed to cut rates at every meeting over the next year, it does fit with the idea that the Fed needs to normalize monetary policy over the foreseeable future."

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