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One of Wall Street’s main recession signals has been flashing red for almost a year with no big downturn yet, but that doesn’t mean the U.S. economy or the stock market are out of the woods, according to historical examples. The 2-year Treasury yield was trading at 4.752% on Friday, more than 100 basis points , or 1 percentage point, above the 10-year Treasury yield . The 3-month yield is even higher, at roughly 5.299%. The yield curve is considered inverted when short-term rates are above long-term ones, a phenomenon that has almost always predated a recession. The idea is that lower long-term rates suggest that bond traders expect a recession and Federal Reserve rate cuts in the years ahead. 10Y2YS 1Y mountain The U.S. Treasury yield curve has become deeply inverted over the past year. But despite the deeply inverted curve, stocks are rallying — even the economically sensitive industrial names. However, Strategas strategist Chris Verrone highlighted two prior times in history when similar combinations ended poorly for investors. “With the 2/10 curve again hovering near 100bps and the inversion entering its 12th consecutive month (3rd longest on record), we remain intrigued by both 1979 and mid 2006 to mid 2007 episodes. As we’ve highlighted over recent months, those periods mark the two largest S & P rallies with an inverted curve,” Verrone said in a note to clients Thursday. “Both were in the progression towards a recession, and both [stock market rallies] expired around +28% low to high,” Verrone added. On Thursday, the S & P 500 closed 22.5% above its October bear market low. The U.S. economy has so far defied historical trends and expert predictions about a looming recession. Goldman Sachs economists recently cut their forecast for a recession in the next 12 months to just 25% , and the labor market has continued to add jobs. But that doesn’t mean that a potentially harsh recession isn’t on the horizon, according to Wolfe Research’s Chris Senyek. He also drew a connection between the current yield curve and the market conditions in the late 1970s. “In our view, equity market investors are largely ‘looking through’ this classic recession signal. More specifically, we believe that Fed actions in response to the regional bank crisis and Fed Chair [Jerome] Powell’s reluctance to strongly emphasize the FOMC’s inflation focus eased overall financial conditions and pushed out the upcoming downturn. Looking ahead, we expect an even deeper inversion as the Fed remains ‘higher for longer’ and a deeper-than-expected recession starts to hit later this year,” Senyek said in a note to clients Thursday. The late-1970s comparison could be especially concerning for investors, as persistent inflation led to an infamous “double-dip” recession — back-to-back recessions with a few months of growth between them —in the early 1980s when Fed Chair Paul Volcker raised rates sharply to bring prices under control. — CNBC’s Michael Bloom contributed to this report.
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