- The economy could be in for pain even if there's a soft-landing, according to market veteran Ed Yardeni.
- De-inversion of the yield curve is often cheered, but a risk today is the 10-year yield moving even higher, in line with short-term yields.
The bond market is flashing a worrying signal that more pain may be in story for the economy, according to market veteran Ed Yardeni.
The Yardeni Research president pointed to signs of cooling inflation in the economy, which has caused more investors to dial back their expectations of a downturn.
But there's still risk in the system, Yardeni said, thanks to troubles unfolding in the bond market.
That's because the spread between the 2-year and 10-year Treasury notes – a notorious indicator of a coming recession–can de-invert as financial conditions loosen. That typically happens when short-term yields fall back below longer-term bond yields, which tends to be bullish for stocks.
But long-term yields today are actually edging higher, with the 10-year Treasury pushing solidly back over 4% in recent weeks after trending down earlier in the summer, trading at 4.185% on Monday.
In an atypical yield curve de-inversion, long-term rates rise and catch up with short-term interest rates, which are currently hovering around around 5%, Yardeni said.
Higher long-term rates is bad news for banks, which are already suffering from higher interest rates and shaky bases of deposits. Higher rates would also likely be "complete disaster" for the commercial real estate industry, a sector that has around $1.5 trillion worth of debt that will soon need to be refinanced.
"[The] number one risk now is the de-inversion that occurs in the yield curve occurs in an unusual fashion," Yardeni said in an interview with CNBC on Monday. "That could create a whole new set of problems to the economy."
The good news is that the Fed is likely to dial back interest rates next year thanks to cooling inflation. Prices increased 3.3% year-over-year in July, a dramatic slowdown from 9.1% last summer.
Lower real interest rates are likely to bring bond yields down. Markets are largely anticipating the Fed to keep interest rates level at its September policy meeting, and investors think rate cuts start to look likely in the first quarter of 2024, according to the CME FedWatch tool.