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A very important yield curve hasn't inverted

Data: Federal Reserve Bank of St. Louis. Two-year, Three-month; Chart: Andrew Witherspoon/Axios

The 10-year/3-month yield curve inverted on Friday and has remained underwater since, but the 10-year note continues to hold a higher yield than the 2-year note, keeping that yield curve positive.

Why it matters: While many consider the 10-year/3-month curve inversion to be a better recession predictor, the 10-year/2-year inversion has precipitated every U.S. recession since World War II.

Details: The 10-year/2-year curve has typically inverted just before the 10-year/3-month curve. It inverted days after the 10-year/3-month curve in 2006 before the Great Recession and ahead of the 1991 and 2000 recessions, according to Federal Reserve data.

The big picture: Investors say a recession is now being priced in, but 1-6-month T-bills hold higher yields than 2-year notes because of uncertainty about what comes next from the Fed.

  • "The market is more worried about the potential for an economic slowdown than the Fed has signaled a willingness to cut rates," BMO Capital Markets' rate strategist Ian Lyngen tells Axios. "Implicitly, the market is testing the Fed’s resolve to keep rates on hold."

Fed fund futures prices show the market sees a 77% chance the Fed cuts rates before December and a 25% chance of multiple cuts this year., according to CME Group's FedWatch. That's a complete reversal from just a week ago when the market saw a 76% chance the Fed would hold rates steady at 2.25%–2.50%.

  • The market has priced a 0% chance of a rate hike this year.

The intrigue: Every yield maturity from 1-month bills to 2-year notes hold higher yields than the 5-year note, and the 6-month bill has the second-highest yield on the curve, trailing only the 30-year note.

  • Investors are typically paid more for holding longer-dated maturities. An inversion of that theme shows greater market fear about what's happening in the short term than in an impossible-to-predict economic climate 10 years or more in the future.

What to watch: The 6-month T-bill has especially high yields because of fear over the recently breached debt ceiling, which will require congressional action to raise by late September or early October, analysts tell Axios.

Go deeper ... Will the yield curve lead to recession? It really is different this time.