Bond Traders Bet on ‘Nirvana Scenario’ in New Yield-Curve Theory

Listen to Wall Street’s top economists and you’ll hear the same message again and again: The risk of a recession is fading fast. And yet, in the bond market, the traditional warning that a downturn is near — an inversion of the yield curve — keeps getting louder.

Ed Yardeni, an economist who’s been covering the market since the 1970s, has an explanation.

The yield curve, he posits, is signaling the slowdown in inflation that typically accompanies a recession but not the actual recession itself. He calls this the “Nirvana scenario” — all the gain (an end to nasty price increases for consumers) without much pain (a spike in unemployment or a major hit to the stock market). And that’s manifesting itself in the Treasury market the exact same way that a looming recession would: high yields on short-term debt and lower ones on longer bonds as traders anticipate the Federal Reserve will start cutting interest rates next year.

This Time Might Be Different

“It’s conceivable that the interpretation of what the yield curve is saying here is that the Fed managed to succeed in bringing inflation down,” Yardeni, who runs Yardeni Research, said in an interview. “The economy has proven to be remarkably resilient and the Fed may not have to raise rates much higher.”

There will almost certainly be at least one more rate increase this year. Traders and economists are in near-unanimous agreement that Fed Chair Jerome Powell will oversee a quarter-point hike when he and his colleagues conclude their two-day meeting on Wednesday. It would be the 11th hike since early last year and bring the benchmark rate to a range of 5.25% to 5.5%.