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U.S. yield curve inverts for first time in 12 years, flags recession

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NEW YORK/LONDON (Reuters) - The U.S. Treasury yield curve inverted on Wednesday for the first time since June 2007, in a sign of investor concern that the world’s biggest economy could be heading for recession.

The inversion - where shorter-dated borrowing costs are higher than longer ones - saw U.S. 2-year note yields rise above the 10-year yield.

Weak economic data and low inflation around the world, global trade conflicts and political tensions in places such as Hong Kong have sparked worries about world growth, fueling market expectations of central bank interest rate cuts and triggering steep falls in government bond yields.

The U.S. curve inverted on Wednesday to as much as minus 2.1 basis points US2US10=TWEB, a metric widely viewed as a classic recession signal. The last time this yield curve inverted was in June 2007 when the U.S. subprime mortgage crisis was gathering pace.

The U.S. curve has inverted before every recession in the past 50 years, offering a false signal just once in that time.

The curve was last up 1.4 basis points.

(GRAPHIC - US Treasury curve inverts: tmsnrt.rs/2YLaA5f)

Jeffrey Cleveland, principal and chief economist at investment management firm Payden & Rygel in Los Angeles, said he is more optimistic about the timeline for a recession.

“We look at 2s/10s and the yield curve in general as long leading indicators,” Cleveland said. “Long because a long period can elapse between inversion and a recession. For example, 2s/10s inverted in December 2005 and the recession did not begin until December 2007: a full 24 months.”

With the inversion, U.S. benchmark 10-year yields fell to 1.574%, the lowest since September 2016, while 30-year yields tumbled to a record low of 2.015%.

“I don’t think we have seen the bottom in yields yet as we continue on this path of just absolute increased uncertainty,” said Ellis Phifer, market strategist at Raymond James in Memphis. “I think potentially the bottom could be the 1.30%-1.35% in the 10-year.”

In midday trading, U.S. benchmark 10-year Treasury note yields US10YT=RR were last down at 1.586%, from 1.68% late on Tuesday.

Yields on 30-year bonds slid to 2.04% US30YT=RR from 2.137% on Tuesday.

While the yield on nominal 30-year bonds had not yet broken below 2% for the first time ever, Treasury futures market signals indicated an expectation that it would do so soon. The implied yield on the 30-year Treasury futures contract expiring in September USU9 was 1.74% on Wednesday, near a record low.

At the short end of the curve, U.S. 2-year yields fell to 1.571% from Tuesday’s 1.669% US2YT=RR.

In March, the inversion of the U.S. yield curve hit 3-month T-bills for the first time in about 12 years when the yield on 10-year notes US10YT=RR dropped below that for 3-month securities.

That metric reverted back and then inverted again in May. Over that period, the 2- to 10-year curve did not invert.

Some have cast doubt on how accurate the yield curve remains as a recession predictor after a decade of multitrillion-dollar central bank money-printing stimulus.

“The supply-demand dynamics for safe assets are different and to some degree it explains why the curve inversion may last longer without portending recession than during past episodes,” Tim Graf, chief macro strategist at State Street Global Advisors said.

(GRAPHIC - Bonds: tmsnrt.rs/2YN5XYj)

(This story has been refiled to correct typographic error in 4th paragraph to make RIC for yield curve US2US10=TWEB instead of US2US10YT=TWEB)

Reporting by Gertrude Chavez-Dreyfuss in New York, Dhara Ranasinghe in London and the London Markets team; Additional reporting by Dan Burns; Editing by Jonathan Oatis

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