The Inverted Yield Curve
The Inverted Yield Curve
The yield curve is a line on a graph, where x=the interest rate and y=time, showing interest rates increasing as the length of loans increases, represented by a line sloping higher as time increases.
More simply, longer term interest rates for loans are usually higher than shorter term loans. The longer a loan needs to be, the higher the interest rate will be to reflect the additional period of time that the creditor cannot spend their money.
An inverted yield curve is where shorter term loans are yielding higher interest rates than longer term loans, represented by a line dipping downward (inverting) at some point as time increases. This does not happen in a free market and reflects a distortion in the market.
The two yield curve inversions that predicts a recession are the 2 year treasury yield vs the 10 year treasury yield and the 3 month treasury yield vs the 10 year treasury yield.
Thomas Franck, in a March 22, 2019 CNBC article titled, Part of ‘Yield Curve’ Inverts as 3-month Yield tops 10-Year Rate, writes,
“‘I’d highlight that the 3-month to 10-year spread is important because the Fed has done a lot of research on which best predicts future recessions and it found that one to be preferable,’ said BMO Capital Markets rates strategist Jon Hill.
Hill added that while that the recent inversion does not guarantee a recession, BMO’s work on the Cleveland and New York Fed’s models suggests a 30 percent chance of a recession in the next 12 months. One of the most popular spreads to watch across Wall Street is that between the 2-year Treasury yield and the 10-year Treasury yield, which remains positive.
President Donald Trump’s chief economic advisor, Larry Kudlow, agreed that the spread between the 3-month yield and the 10-year yield is the most important difference to monitor.
‘It’s actually not 10s to 2s: it’s 10s to 3-month Treasury bills,'‘ Kudlow said in May.”[1]
On Friday, March 22, 2019, the 3 month treasury interest rate yield was higher than the 10 year treasury yield for the first time since 2007 (yield curve inversion). As of Sept 11, 2019, it has been inverted since the middle of May.
The 2 year vs 10 year treasury inverted on August 14, 2019 for the first time since May 2007.[2]
December 2007 marked the beginning of the Great Recession.[3]
[1] https://www.cnbc.com/2019/03/22/us-bonds-treasury-yields-move-lower-as-investors-await-economic-data.html
[2] https://www.zerohedge.com/news/2019-08-13/recession-alert-ust-2s10s-yield-curve-inverts-first-time-12-years