Inverted yield curve warns of recession

Updated: Aug 29, 2019

An inverted US yield curve is an interest rate condition that takes place when the longer-term yields (i.e., 30-year or 10-year US treasuries) are lower than the shorter-term yields (i.e., 2-year or 3-month US Treasuries). Studies have shown that an inversion or an inverted yield curve can be a precursor to a recession or an economic contraction. Some postulate that an abnormal change in the slope of the yield (inverted) reflect changing expectations about the economy, and these expectations can then help warn of impending economic turns. So what are the negative spreads during June '19 (10-year minus 2-year and 10-year minus 3-month) telling us about the US economy and the financial markets?

Since 1970s inversions or negative spreads have led to subsequent US recessions including 1980/1981-1982 double dip recession, early-1990s recession, early-2000s tech/telecom bubble induced recession, and the 2007-2009 global recession. In each of these occurrences of the spreads contracted sharply to unsustainable negative levels (below 0) before finally reversing and expanding sharply higher triggering recessions.

It appears the 10-year minus 3-month spread can be especially useful in helping to predict the timing of the next US recession. In the past, US recessions tend to develop approximately 11-months after the spreads turned negative. For example, yield inversion dates and subsequent US peak dates: Dec '68/Dec '69, Jun '73/Nov '73, Nov '78/Jan '80, Oct '80/Jul '81, Jun '89/Jul '90, Jun '00/Mar '01 and Aug '06/Dec '07.

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