Yield curve indicates economic weakness, lower inflation

In March 2022, the USD swap curve became inverted and by the end of August the difference between the 2-year vs 10-year tenors fell to -0.6% (see also Alternative Credit Letter in April), a signal of economic weakness ahead.

In June this year, the Fed funds futures curve also inverted, pointing to a more dovish stance of the Fed by mid-2023. This uncertainty about the future path of interest rates is caused by rising fears of recession and a potentially faster cool-down in inflation as a result of rate hikes. However, this interpretation might prove to be too optimistic as the wage-price spiral could become a more dominant factor. In general, volatility at the short end of the curve was particularly painful for short duration bonds, both in terms of interest rate and credit risk.

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