Treasury Yield-Curve Inversion Reaches a Four-Decade High, as Fed Warned of 'low' liquidity

The Federal Reserve confirmed on Friday what has been spreading for some time: the $24 trillion Treasury market has been experiencing low levels of market liquidity in recent months, as treasury yield reached new extremes of inversion last week, touching a level not seen since the early 1980s.

The central bank has rapidly increased interest rates since March to bring inflation down from a 40-year high. But since May, cracks in Treasurys have begun to emerge.

Both the 2-year Treasury and the 10-year Treasury rates have shot above 4% since May, highs last seen around 2008. The two-year note's yield exceeded the 10-year note's by as much as 58.6 basis points this Thursday. The inversion briefly exceeded 58 basis points on Aug. 10, last seen about forty years ago when then-Fed Chair Paul Volcker's rate hikes to break inflation tanked the economy.

The last five 2-10 inversions have eventually led to recessions. A recession occurs, on average, 22 months following a 2-10 inversion, according to Credit Suisse.

"Liquidity metrics, such as market depth, suggest that Treasury market liquidity has remained below historical norms," the Fed said Friday in its latest financial stability report. "Low liquidity amplifies the volatility of asset prices and may ultimately impair market functioning."

The report noted that liquidity issues " could also increase funding risks to financial intermediaries that rely on marketable securities as collateral," as well as potential ripple effects that could amplify financial stability risks.