DoubleLine's Gundlach: Treasury curve inversion signal 'economy poised to weaken'

A trader works on the floor at the New York Stock Exchange in New York City US Dec. 4

A trader works on the floor at the New York Stock Exchange in New York City US Dec. 4

WASHINGTON-Top U.S. Federal Reserve officials say a strong economy will likely keep their rate increase plans intact, but on December 3 a key signal began to waver that may intensify debate about whether conditions are as solid as they seem.

The dollar has been under pressure since Federal Reserve Chairman Jerome Powell said last Wednesday that USA interest rates were nearing neutral levels, which markets interpreted as signalling a slowdown in the pace of rate hikes.

Comments on Tuesday by New York Fed President John Williams about the path of interest rate hikes added to the uncertainty for investors. A rate hike however, while signaling confidence by the Fed, would continue to make financing more expensive for firms and households.

- CNBC's Sam Meredith and Ryan Browne contributed to this article.

Those worries on Tuesday saw two-year yields rising above those of longer-dated 5-year notes for the first time in more than a decade.

Germany's 10-year bond yield fell to its lowest in four and a half months at 0.265 percent and was last down 4 bps on the day.

Hong Kong's Hang Seng retreated 1.55 percent and the Shanghai Composite Index dipped 0.2 percent. The two-year, 10-year yield curve is a key focus for investors as an inversion is seen as predictor of a U.S. recession.

Given the current functioning of the world economy, "arguments are made that a flatter yield curve has less of a signal embedded in it" about coming economic performance. "We are following a strategy and taking account of data over time as it comes in and in response to significant changes in direction".

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Yesterday, a part of the yield curve inverted.

Whatever the situation with the Fed and the USA markets, emerging markets may be effected even more than the US economy.

"If that is indeed to be the case, the recent strong equity recovery is at risk from fundamental economic deterioration, a message that is sounding from the junk bond market, whose rebound has been far less impressive", he said.

Williams said the U.S. central bank should expect to continue raising interest rates "over the next year or so" even while it pays close attention to possible risks highlighted by financial markets.

But since then, it has persistently declined, especially since the middle of last week, and now is at its narrowest since July 2007, on the eve of a steep recession.

So far, there has been no inversion of the two-year and 10-year. As the spread between two- year and 10-year securities neared zero, the gaps between some other yields, including the two year and three year, were already upside down.

"What sounds good at the dinner table becomes rather hard at the negotiating table - the market now knows how to read Trump, he knows how to create big news at bilateral meetings but then when it comes to the nitty gritty it can be a very different story", he said. That's in part because investors expect the Federal Reserve to raise interest rates in the future as the economy and inflation power higher.

The outlook for US growth, by contrast, he said remained strong.

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