One of the bond market’s most watched recession indicators has been showing the possibility of a downturn for nearly two years, even though the U.S. economy has yet to contract. That’s likely to continue, according to Ralph Axel and Katie Craig, interest rate strategists at Bank of America Securities.

In a report released Thursday, they explain why this part of the Treasury yield curve, which has been inverted, or sloping downward, won’t see a major shift. They say the difference between 10-year and 2-year Treasury yields, which have now been negative for more than 480 consecutive trading days, is partly because the Federal Reserve may cut rates more slowly than expected.

The 2-year and 10-year Treasury yield spread is one of many barometers of the bond market’s view of the U.S. economic outlook. The gap is negative when the 2-year rate is higher than the 10-year yield — a situation that has persisted since July 2022, just weeks after the Fed’s first aggressive 75 basis point rate hike to combat inflation.

Interestingly, the gap has remained below zero even after recession fears gave way to more optimistic views among traders that the U.S. can avoid a recession while inflation continues to ease. The gap between the 2-year and 10-year Treasury yields, which once exceeded 100 basis points in mid-2023, has narrowed slightly and was negative 44 basis points on Thursday. Although a recession could take up to two years after the 2-year and 10-year Treasury yield gap inverts, some experts have raised the possibility that the indicator may be invalidated.

According to Axel and Craig of Bank of America Securities, the current inversion of the Treasury curve is "a result of expectations of Fed rate cuts - the slower the Fed cuts, the longer the market will expect further rate cuts in the future. The longer the rate cut period, the slower the unwinding of the inversion."

The Fed has kept interest rates unchanged as the U.S. economy continues to be strong and inflation remains high, but traders believe that this may change. New evidence of slowing economic activity has led some to question whether the Fed needs to step in to support the economy. As of Thursday, Treasury yields had fallen for six straight sessions, the longest such streak in at least a year, on concerns about a slowing economy.

In the long run, the gap between 2-year and 10-year Treasury yields has typically moved inversely to the Fed’s policy rate since 1977, according to data from Bank of America Global Research. For example, the gap could start moving more negative in anticipation of a Fed rate cut before an actual recession.

However, that has not been the case in recent years.

Currently, the Fed is still waiting to see whether to adjust interest rates when it meets again on June 11-12, while central banks elsewhere are already taking action. On Wednesday and Thursday, the Bank of Canada and the European Central Bank each cut borrowing costs by 25 basis points. Meanwhile, traders of federal funds futures do not expect the U.S. central bank to start cutting rates until September, and even then, only two cuts are expected in 2024, compared with as many as six or seven cuts expected at the beginning of the year.

According to Dow Jones Market Data, the gap between 2-year and 10-year Treasury yields has been inverted since July 5, 2022, and has been inverted for 483 consecutive trading days as of Thursday. The gap was briefly inverted for a few days in early April 2022, but then rebounded above zero until July 5 of the same year.

According to data since November 1977, the previous longest inversion record was from August 1978 to May 1980, with a continuous inversion of 446 days.