Dollar weak as U.S. Treasury yield curve inversion sparks recession fears

The Flattening Yield Curve Just Produced Its First InversionsMore

That boosts the cost of borrowing for American households, and in turn pushes short-term Treasury bill rates higher, while putting downward pressure on long-term rates.

The dollar edged lower on Tuesday as U.S. Treasury yields fell, feeding fears that the Federal Reserve could pause in its rate-hike cycle, while an inversion in part of the yield curve was taken as a red flag for a potential recession. In a flat yield curve, there's little difference between short-term yields and long-term yields.

The Dow retreated 3.1 percent and the Nasdaq sank 3.8 percent on Tuesday.

U.S. Federal Reserve officials convinced the massive U.S. bond market has fundamentally changed in the last decade are about to test their commitment to that idea against investors who have begun betting against the U.S. central bank's ability to continue raising interest rates.

"There can't be another screwup like last time, when they dropped "accommodative" but simultaneously characterized the Fed funds rate as "a long way" from neutral", Gundlach said.

Meanwhile, the flattening U.S. yield curve weighed on investors' minds.

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LONDON, Dec 4 (Reuters) - The gap between Germany's two-year and 10-year bond yields tightened to its narrowest in 17 months on Tuesday, after parts of the U.S. Treasury yield curve inverted overnight as optimism over the U.S.

However, despite its track record, many economists question the reliability of the yield curve for predicting recessions, including Powell. A survey of supply managers indicated manufacturing output would grow, but the same survey indicated weaker prices; meanwhile, a decline in construction spending led some analysts to mark down their forecast for gross domestic product growth. The Fed may try to reassure markets that the economy is doing well and that it is not anxious by continuing with their planned rate hike of a 25 basis points or they may single a delay of the hike.

Regardless of other possible reasons, "it is mainly indicative of worries about how long growth in the USA can remain so strong". However, interest rate futures traders are now pricing in only one rate increase during 2019, below Fed projections of three, according to the CME Group's FedWatch Tool.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either.

Yield-curve inversions typically occur months - or even years - before a recession. On Monday of this week, the US government's five-year bond yielded less interest than the three-year bond. Benchmark 10-year notes gained 13/32 in price to yield 2.966 percent the lowest since September 13.

Recent news has contributed to flattening the curve, including a speech on November 28 by Fed chair Jerome Powell interpreted by many as signaling a U.S. slowdown. The yield curve has flattened as continuing interest rate hikes send short-dated yields higher, while longer-dated Treasuries are supported by tepid inflation and slowing global growth.

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