The markets favorite recession indicator reverts back to safe territory for the first time in months

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• The spread between three-month and 10-year US Treasury bonds turned positive on Friday for the first time since July.
• The relationship — know as the yield curve — has been inverted for months, issuing a signal that’s preceded each US economic recession since 1950.
• Positive news on trade talks between the US and China and Brexit progress drove a sell-off in Treasurys, which helped the curve un-invert.
• Read more on Business Insider.

A long-watched recession indicator briefly turned positive Friday on news that a partial trade deal between the US and China may be in the works.

Treasurys sold off Friday on the trade news, pushing the yield on 10-year government bonds up 9 basis points to 1.703% as prices declined. That put the 10-year yield higher than the yield on the three-month Treasury, which declined slightly to 1.676%, making the spread between them roughly a basis point. 

It’s the first time that the spread between the two — called the yield curve — has been positive since July. This is important because an inversion of the three-month and 10-year spread has preceded every US recession since 1950.

The reason for the yield curve reversion was the market’s positive reaction to news on trade between the US and China, as well as Brexit, Charlie Ripley, a senior investment strategist for Allianz Investment Management, told Markets Insider in an interview. 

Markets rallied after President Trump tweeted that “good things are happening” early Friday, indicating that trade negotiations between the US and China were going well into the second day in Washington. In Europe, there are also signs of progress with Brexit as the EU agreed to enter talks with Boris Johnson.  

“We’re seeing rates lifted on that positive news and equities are following,” Ripley said.

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The boost in equities and the sell-off in treasuries spilled over into other assets as well. Gold, traditionally a safe-haven asset that investors flock to when they’re worried about risk, fell further below $1,500 an ounce, a key psychological level.

Having the yield curve back in positive territory could be a good sign for the future, according to Seema Shah, chief strategist at Principal Global Investors. 

“US recession risk has primarily been driven by weakness associate with the US/China trade war, so good news in that arena should lower recession risk, and therefore the need for Fed cuts,” she told Markets Insider in an email. 

So far, the market seems to agree. The probability of a rate cut at the Fed’s October meeting dropped to 66.8%, according to the CME FedWatch Tool. Last week, traders were forecasting the probability of a 25 to 50 basis point cut as high as 90%. 

But even though the yield curve is now in the green, an inversion is still a good signal that a recession could be on the horizon, Ripley said. 

“For us it brings up that it’s something to keep an eye on, but we’re looking at other things” as well, he said. 

Going forward, he’ll keep an eye on business sentiment, which has been low, and jobless claims, an important measure of the health of the labor market.

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