As the yield curve continues to flatten, there has been increased focus on the potential for “inversion” which means that short-term rates are higher than long-term rates. Central bankers have begun mentioning it, we have seen an increase in media mentions, and we have even received a few questions from clients. Below is a chart of the difference between the 10-year US Treasury yield and the 2-year US Treasury yield. The 10-year yield is usually higher than the 2-year yield, but short-term rates surpass long-term rates every now and then. Historically, these inversions have occurred prior to recessions (as indicated by red vertical bars).
A few observations:
- The yield curve may very well invert, but has not inverted yet. The curve almost inverted in 1994, but did not and the next recession was not until 2001.
- The recessions charted above have began 12-24 months after the curve first inverted, while it was nearly 3 years after the 1998 inversion.
- With rates at historically low levels, there are good reasons to doubt that a flat or inverted yield curve is as predictive as in the past. We have our opinions, but it always pays to see multiple sides of an issue and no indicator should ever been overly relied upon or used in isolation.
The above being said, we do not think that the yield curve is indicating an imminent recession. Of course, the shape of the yield curve does have implications for risk/return dynamics and portfolio positioning and investors should adjust accordingly.