Wall Street has been spooked by an economic risk indicator of potential recession as U.S. Treasury long-term interest rate “inverted” to fall below the short-term interest rate.

Interest rates on long-term borrowing should be lower than the interest rate on short-term borrowing, because business has more knowledge of the current economic environment than of the future environment. But if investors believe the economy is already in trouble, long-term interest rates “invert” by dropping below short-term rates.

U.S. Treasury yields on May 29 were inverted with the three-month Treasury bill yielding 2.36 percent and the 10-year Treasury note yield fell to 2.238 percent, its lowest since September 26. With “inversion” creating recession fears, the Dow Jones Industrial Stock Average has fallen over the last week by almost 3 percent to close at 25,126.

But the history of inverted yield curves as a recession indicator is problematic. The average delay after a big yield curve inversion before the start of a recession is about 14 months, but the lag has varied from 1 month to 18 months. The recent inversion that began on March 14, saw stocks move higher in April, and then fall through May. 

But yield curve inversions can happen over short-term periods, such as the inversions in 2005 and late 2018. In both cases panicked investors dumped stocks on recession fears, only to see the economy recover and stock markets generate double-digit gains.

Long-time publisher of the Wall Street Examiner Lee Adler, who specializes in tracking liquidity flows in markets, advised after stocks plummeted by 221 Dow points on Wednesday that the latest inversion may be a “false flag” caused by the reimposing of federal debt ceiling on March 2. As a result, the U.S. Treasury cannot increase its borrowing by selling more short-term Treasury bills to pay the government's bills.

Adler advises that with “solid April tax collections, the Treasury’s cash account was bulging” with a “near record $423 billion on April 30.” The excess cash since April 2 has paid off $136 billion in outstanding T-bills held by banks and Wall Street bond dealers.

Given the legal requirement for financial institutions to hold reserves in non-interest-bearing cash or Treasury securities, that $136 billion has been rushing to “buy 2 and 5 and 10-year Treasuries,” pushing bond prices up and yields down.

Adler believes the supply and demand gyrations in the U.S. Treasury market may be short lived, since the U.S. Treasury has spent $177 billion of its cash hoard as of Friday. The $246 billion cash balance might fund the U.S. government through mid-July.

At that point, either the Democrat House majority votes to raise the debt limit above $22 trillion to avert a crisis, or the Treasury can slow its spending using "extraordinary measures" to raid internal accounts and selectively pay bills. But by sometime this fall, the U.S. Treasury will run out of cash and the America will be at risk of debt-default.

Adler warns that given the existential economic pain associated with a debt-default, Congress will eventually do a deal with President Trump to raise debt ceiling. The Treasury will quickly sell huge amounts 2, 5, and 10-year debt. That will eliminate the inverted Treasury yield curve by driving up Treasury bond yields by driving down prices.

Chriss Street is an economist and cofounder of the New California movement.