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With the economic expansion nine months from being the longest in U.S. history, the yield curve nearly flat and housing market indicators peaking earlier this year, it doesn’t take much imagination to see what’s next: a recession and falling interest rate cycle – i.e., a U.S. Treasury bull market. This article studies the history of these cycles and offers a roadmap for the upcoming one.

The history

There have been three major U.S. Treasury bull markets coinciding with recessions in the last 30 years (orange boxed areas in the chart below). They all look remarkably similar and the periods leading up to them look a lot like now.

First, in all of them, the two-year yield peaked within a month of the last Fed raise in the raising cycle. On average, the 30-year yield peaked about seven months before the two-year peak (albeit with a wide range, from one and a half months to 1.4 years) while the Fed was still raising rates. In general, this happens because Fed policy reacts to a narrow view of the economy, half of which is old news.

The Fed is primarily concerned with stable prices (inflation) and employment. Employment is a coincident indicator of the economy, but inflation reliably lags it, often by more than a year. At these yield peaks, the 30-year yield will start falling as financial assets or leading economic indicators start to erode, but inflation tends to still rise (see inflation peaks in chart above) which keeps the Fed, and its closely-linked two-year yield, rising for a longer time.

Second, these bull markets began far before their accompanying recession did. The bull markets started an average of 1.8 years before. This happens because the start of a recession is marked by a decline in real economic activity, yet long-term Treasury yields start to move lower from the mere hint of a slowdown in activity. This is important because many familiar commentators and banks (Ray Dalio, Ben Bernanke, Nouriel Roubini, Mark Zandi, Societe Generale, JP Morgan) are warning of a recession in 2020. This 1.8-year average combined with a mid-2020 recession would suggest a U.S. Treasury bull market beginning around now.