The gap between short- and long-term borrowing costs in the United States has reached its widest point since 1981, a sign that investors expect the Federal Reserve to stay the course in its battle to tame inflation, even as recession fears mount.

the two years treasury On Wednesday, the yield traded at 4.2 percent, while the 10-year yield settled at 3.4 percent, bringing the difference between them to 0.84 percentage points. This pattern, known as the “inversion” of the yield curve, has preceded every US economic downturn in the past 50 years.

The deepening of the reversal comes after last week’s report showed that American economy Job additions continued at a strong pace in November, and a significant survey indicated that activity in the broad service sector continues to grow rapidly.

While the data paints an optimistic picture of the state of the economy, some investors worry that it will also be encouraging feed it To continue to push interest rates higher next year, after moving them from near zero to a range of 3.75-4 percent so far in 2022. Higher borrowing costs, in turn, are expected to add pressure on the economy, potentially lead to stagnation.

The market was betting that the Federal Reserve would have to slow down. “We’ve learned in the last year that the market has been wrong time and time again on this assumption,” said Edward El-Husseini, senior analyst at Columbia Threadneedle.

Shifts in the US bond market also show that investors are moving more in line with what the Fed said it expects for next year. Although the yield curve has been flat throughout the year, it has rebounded from its lows in late November and last week investors began pricing in two interest rate cuts by the end of 2023, both of which point to a backsliding in monetary policy.

This gap was between the Fed and the market particularly clear After President Jay Powell’s speech last week In which he indicated that although the US central bank will slow down the pace of interest rate increases at its December meeting, it will do so to allow interest rates to stay higher for a longer period. Markets focused on the first lot, not the second.

After the release of the US jobs report on Friday, the intense movement in the yield curve collapsed, although interest rate cuts next year are still priced in. Futures markets currently suggest the “final” Fed rate, or peak for this cycle, will be around 5 percent in May, from expectations as low as 4 percent in September.

“The [November] The payroll report reminded us that the labor market remains in a very good place, and we expect to see that reflected in a higher final rate in points,” said Ben Jeffrey, US pricing analyst at BMO Capital Markets, referring to the Fed’s quarterly survey of officials on where Economics and Monetary Policy in the Years Ahead – Also known as a “dot chart.” The next dot chart will be released at the Federal Reserve meeting in December.

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The primary signal that a yield curve inversion sends is that investors believe that the Fed’s increases in short-term interest rates will succeed in slowing inflation sharply. Then the magnitude of that reversal reflects both the dramatic pace of interest rate increases, and the fact that the Fed has held onto that pace even as investors shifted their inflation and growth expectations.

“We think the shape of the yield curve is a measure of how much monetary policy can tighten, and the market clearly believes that tightening will continue for some time,” said Mark Cabana, head of US interest rate strategy at the bank. from America.

Credit Suisse’s Jonathan Cohn added that the deep inversion of the yield curve indicates that investors believe the Fed is committed to “moderating inflation even if it has to sacrifice forward-looking growth or stagnation.”

in December Exploratory study Conducted by the Global Markets Initiative at the University of Chicago Booth School of Business in partnership with the Financial Times, 85 percent of economists said they expect the National Bureau of Economic Research — the arbiter of a US recession — to announce one within the next year.

Although the yield curve has been a reliable predictor of a recession, information conveyed on the depth and extent of the reversal is up for debate.

“An inverted yield curve is actually a fairly good signal of a recession, without providing information about its depth or severity,” said Jay Lepas, chief fixed-income strategist at Janney Montgomery Scott.

“In this case, the inversion probably tells us more about inflation and the direction of inflation risks than it does about the depths or severity of a recession.”

While strategists like LeBas argue that the degree of inversion of the yield curve may not directly predict the extent of the upcoming recession, the current deepening could have broader ramifications if it leads to changes in investor behavior.

“The most important aspect of the yield curve is what it does to risk,” said Gregory Peters, chief investment officer for fixed income at PGIM. “It’s a self-reinforcing mechanism.”