On Wednesday, September 4th, following the release of data showing that the US JOLTS job openings for July fell more than expected to a three-and-a-half-year low, evidence of a weak labor market led traders to increase their bets on a significant rate cut by the Federal Reserve. This also led to a sharp drop in the yields of US short-term bonds, which are more sensitive to interest rates.

The yield on two-year US Treasury notes fell more than 11 basis points to 3.774% at one point, reaching a new low not seen since the end of April last year. The yield on the 10-year benchmark Treasury note, known as the "anchor of asset pricing," fell as much as 7.5 basis points to 3.768%, hitting a two-week low since August 21st.

However, during the decline in yields, the two-year/10-year US Treasury yield curve, which serves as a forward-looking indicator for the economy, briefly ended its inversion for the second time since June 2022, the last occurrence being during the market plunge on August 5th in the European and American stock markets. That is to say, for the second time in two years, the yield on the 10-year Treasury note briefly rose above that of the two-year note.

Dow Jones market data shows that since July 1, 2022, there has not been a single instance where the yield on long-term US Treasury bonds closed higher than that on short-term bonds. If this were to happen, it would end the longest recorded period of yield curve inversion, which, as of Tuesday this week, has been inverted for 543 consecutive trading days.

The weak labor data fueled bets on a Federal Reserve rate cut, leading to a brief end to the yield curve inversion.

Generally speaking, an inversion of the key US Treasury yield curve is a harbinger of an economic recession. In March 2022, as the Federal Reserve initiated its most aggressive tightening cycle in decades, the Treasury yield curve inverted. In March 2023, the yield on two-year Treasury notes was once 111 basis points higher than that on 10-year notes, marking the largest inversion since the early 1980s.

Analysts have pointed out that since World War II, the reason for the inversion of the yield curve, where shorter-term Treasury yields are higher than longer-term yields, is essentially the result of traders incorporating expectations of future economic slowdowns into their pricing. Otherwise, the uncertainty of holding longer-term bonds should demand higher yields from long-term bonds:

"Thus, the improvement in the yield curve inversion tells us that, even with a brief economic recession, the economy is likely to stabilize and resume growth in the long term as the Federal Reserve starts cutting rates from this fall.

Expectations of a rate cut announcement by the Federal Reserve after the FOMC meeting on September 18th are pulling down short-term bond yields, while expectations of strong long-term economic growth and inflation are curbing the decline in the yield on 10-year Treasury notes."

John Fath, Managing Partner at BTG Pactual Asset Management US, stated that if the Federal Reserve does indeed cut rates by 50 basis points, the key two-year/10-year Treasury yield curve may completely end its inversion. Priya Misra, Portfolio Manager at J.P. Morgan Asset Management, also believes that it is very reasonable for the yield curve to end its inversion as the Federal Reserve is about to start cutting rates.Combining the dovish remarks by this year's voting committee member and Atlanta Fed Chairman Bostic, who expressed support for an immediate interest rate cut, U.S. short-term interest rate futures on Wednesday showed that the possibility of a 50 basis point rate cut by the Federal Reserve in September once surpassed the traditional 25 basis point cut. Traders' bets on the Fed's easing efforts within 2024 have also widened, expecting a total of 107 basis points to be cut across the remaining three meetings of the year.

Earl Davis, head of fixed income at BMO Global Asset Management, also stated that evidence of a weak U.S. labor market is significant because it "lowers the bar for the Fed to make a substantial 50 basis point rate cut in September." Once the Fed begins to cut rates by 50 basis points at a time, "it won't be a one-time event; they have ample room for reduction."

However, historically, when the yield curve ends its inversion, economic problems begin to emerge, which may not be entirely positive for the stock market.

Nonetheless, many analyses point out that although the end of the long-term inversion of the U.S. Treasury yield curve usually occurs when the Fed starts to cut rates, the Fed often eases policy when the economy encounters difficulties. Therefore, the end of the yield curve inversion can intensify investors' concerns about a recession, which is also a negative signal for the stock market.

Quincy Krosby, Chief Global Strategist at LPL Financial, stated that statistically, the normalization of the U.S. Treasury yield curve (i.e., the end of inversion) is either because the economy has indeed fallen into a recession or because the Fed is about to cut rates to counter economic slowdown.

This represents that the normalization of the curve does not necessarily predict better days ahead; instead, it implies that the U.S. may still face some tough economic challenges. Moreover, the 3-month/10-year U.S. Treasury yield curve, which the Fed pays the most attention to, is still significantly inverted, with a spread of over 130 basis points.

However, the perspective from Barron's suggests that the U.S. Treasury yield curve has just ended its inversion, which historically has been beneficial for the U.S. stock market. Since 1980, the average return of the S&P 500 index within 12 months after the yield curve first ended its inversion has been as high as 12.2%.

During the six instances of the yield curve ending inversion since the aforementioned period, the S&P index has risen four times, each time achieving a double-digit percentage increase within a year. There were two instances of the index falling, one of which occurred in 2007 when the yield curve ended inversion, just before the outbreak of the 2008-2009 financial crisis:

This year, the stock market's performance may be more similar to the situation in 1989, when a recession occurred after the U.S. Treasury yield curve ended inversion. Even if the economy now enters the market's anticipated "mild and short" recession, the stock market may remain unscathed.

The current glimmer of hope is that the federal funds rate cannot rise further, as the inflation rate has been halved from its peak, which means that even if economic growth slows, it will not decline significantly.Consumers and businesses will have greater spending power, thereby allowing corporate earnings to continue to grow. At the same time, lower interest rates will reduce the attractiveness of bonds relative to stocks, potentially directing more funds into the stock market.