Stuart Canning, research analyst at M&G Investments, has said the temporary yield curve inversion which saw three-year Treasury yields lower than two-year notes is a signal that interest rates in the US may need to come down in the near-term.
On Tuesday, three-year Treasury yields fell below two-year notes for a brief moment before bouncing back.
This has set off a debate among bond investors as to the meaning of the inversion, with one camp arguing it is mainly symbolic while others claiming it indicates a recession is near.
The US Treasury yield curve inversion has been a classic indicator of an oncoming recession in history such as in the build-up to the Global Financial Crisis in 2007 and in advance of the recessions in 1990 and 2001.
Despite the usual signal coming from two-year and 10-year Treasury yields, Canning said the inversion on Tuesday has investors worried.
"This is the first part of the curve to become inverted for some time and could suggest a need for rates to be cut in the relatively near term," he warned.
"The inversion…clearly implies that there is not an insignificant chance the Fed will have to ease in the next few years."
He added the need for the Federal Reserve to tighten monetary policy as fast as it is signalling had been reduced in recent times due to reduced activity in the US housing and car markets, highlighting that consumers are feeling the pinch of higher rates.
Furthermore, in the credit markets, he highlighted the borrowing costs of high yield businesses had increased by over 1% and 0.25% for investment grade companies.
The Fed has already hiked rates three times this year with plans for an increase in December and potentially as many as three more next year.
"There has indeed been a decline in beliefs about how far the Fed will have to tighten in the near term," the analyst said.
"The market implied path of policy rates still suggests a greater likelihood than not of a rate increase at the December meeting, but compared to what was priced in at the end of September, there seems to be a belief that we are less likely to have seen as many increases by Q3 next year."
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