Treasury Curve Settles Into Sweet Spot as Energy Crisis Drags On

The 10-year-2-year Treasury spread sits at 0.5% — right in that Goldilocks zone where it’s positive enough to signal economic health but narrow enough to keep recession fears at bay. The spread has been gently compressing over the past week, down from 0.57% on April 27th, as longer-term rates drift lower despite the ongoing Strait of Hormuz crisis keeping oil near $95.

Here’s what’s interesting: this narrow-but-positive curve suggests bond markets expect the Fed to navigate the energy shock without tipping into recession. The spread typically inverts (goes negative) 12-18 months before recessions, but we’re moving in the opposite direction — away from inversion. That’s significant given that oil prices have jumped 44% since the Strait closure in February. Bond traders seem to be betting that higher energy costs will moderate growth and inflation expectations simultaneously, keeping the Fed on pause rather than forcing aggressive tightening.

Historically, spreads in this 0.4-0.6% range have coincided with late-cycle expansions where growth is slowing but still positive. Think 2018-2019, when trade tensions created uncertainty but didn’t derail the expansion. The current environment feels similar: an external shock (energy) creating headwinds without breaking the underlying economy.

Many professional investors view narrow spreads as a time to be selective rather than broadly bullish. In this type of environment, investors often favor sectors that can pass through higher costs (like technology) while avoiding energy-intensive industrials. The recent rotation into tech — with XLK up 10% versus the S&P 500 over the past month — suggests this playbook is already in motion.

Bottom Line: A positive but narrow yield curve is telling us the economy can absorb this energy shock without breaking. The question is whether that resilience extends to corporate margins as input costs keep climbing.

Source: Federal Reserve Economic Data (FRED)

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