A notorious recession indicator says that an economic downturn will begin this quarter, Bank of America says

• A classic recession indicator is flashing signs that the long-awaited downturn is about to start.
• BofA strategists pointed to two points in the yield curve that have inverted, moves typically followed by a recession.
• "Yield curve says recession starts now; markets await confirmation from labor market," the analysts wrote.  

The bond market's notorious recession indicator has flashed signs of an incoming downturn for months – and history says it's sending a warning to markets that a downturn could kick of this quarter, according to Bank of America strategists.

Strategists pointed to the inverted Treasury yield curves – namely, the spread between the 2-year and 10-year yields, and the spread between the 3-month and 10-year yields. Short-term yields surpassing long-term yields are a highly-watched signal of an incoming recession, with the inverted 2-10 spread correctly predicting the recessions of 1990, 2001, and 2008. 

The analysts say that historically, a recession kicks off six months after the inversion of the 2-10 year curve. Given that those bond yields inverted in November of last year, the recession should be arriving in May. 

The 2-10 year yield curve recently notched its deepest inversion in over 40 years. The inversion steepened in March as the collapse of Silicon Valley Bank unfolded, a move that market can interpret as a major omen for the US economy, the BofA analysts said.

 "Yield curve says recession starts now; markets await confirmation from labor market," strategists said in a emailed note on Friday. "Inverted yield curves signal recession, but once recession begins the yield curve immediately steepens as market discounts Fed policy response to recession," they added in the note.

Meanwhile, the spread on the 3-month and 10-year yields have "barely" steepened, but if the inversion between those treasury yields were to deepen in the following weeks, that would be a strong indicator that a recession is starting in the second quarter, the bank said.

Strategists have been warning of a recession over the past year, as central bankers raised interest rates over 1,700% to tame high inflation. Rates that high could easily push the economy into a downturn, experts say, particularly as Fed officials have signaled rates are likely to remain higher for longer. 

High rates are expected to continue weighing on employment and corporate earnings, which spells trouble for stocks. Though equities are pricing in just a 4% decline to corporate earnings, there's risk that firms could face bigger headwinds amid higher rates and a recession on the horizon, the bank said. 

"We stay bearish as economic ambiguity of 2023 set to end with a crack in labor market & EPS recession," strategists warned.