A key indicator has flagged a US recession as the bond yield curve inverted again on Monday.
The American curve has inverted before each recession since 1955, with a downturn following between six and 24 months, according to a 2018 report by the Federal Reserve Bank of San Francisco.
The spread between two-year Treasury bills and the 10-year segment (2/10) inverted, meaning two-year Treasuries yielded more than 10-year paper.
Short-term yields, which are most sensitive to interest rates, are rising with rate-hike expectations, while higher long-term rates indicate the Fed will be unable to control inflation.
That part of the curve inverted in late March for the first time since 2019 but steepened again as investors priced in rate increases.
What are yield curves?
Yield curves plot interest rates (yields) of bonds with equal credit quality against varying maturity dates, with the slope of the curve implying what future rates and economic activity may look like.
These charts, which often compared the yields of 2-year and 10-year government bonds, are widely used as they often can predict changes in the economy.
Yield curve risk comes from the idea that bond prices and interest rates are inversely related, while curve rates are published on the Treasury’s website on trading days.
Inverted yield curve – downward sloping
In this case, short-term bonds are giving better yields than those with long maturities, which occurs during an economic downturn.
As the economy is getting worse, investors prefer safe investments and so tend to purchase longer-dated bonds over short-term ones, bidding up the price of longer bonds driving down their yield.
How to use the yield curve
Investors evaluate it to predict the direction the economy may be headed in to make investment decisions.
For example, if the curve implies a slowdown is coming then people may move money to defensive assets, including consumer staples, that thrive during recessions.
With steep curves, inflation is thought to be on the horizon, so investors would avoid bonds with long maturities as they diminish with rising prices.
Treasury yield curve
The US Treasury yield curve depicts the interest rates of short-term Treasury bills (maturity under a year) to the yields of long-term bonds and notes.
“The chart shows the relationship between the interest rates and the maturities of U.S. Treasury fixed-income securities,” Investopedia commented.