Inverted yield curve
In finance, an inverted yield curve is a yield curve in which short- term debt instruments (typically bonds) have a greater yield than longer term bonds. An inverted yield curve is an unusual phenomenon; bonds with shorter maturities generally provide lower yields than longer term bonds.[2]
The inverted yield curve has one of the most reliable leading indicators for economic recession during the post-World War 2 era.[Bodie p. 318] The inversion tends to predate a recession 7 to 24 months in advance.[3][4][5][6] However, inversion during a labor shortage and low indebtedness in 2023 raised questions over whether widespread awareness of its predictive power made it less predictive.[7]
History
The term "inverted yield curve" was coined by the Canadian economist Campbell Harvey in his 1986 PhD thesis at Duke University.[8]
Causes and significance
There are several explanations of why the yield curve becomes inverted. The "expectations theory" holds that long-term rates depicted in the yield curve are a reflection of expected future short-term rates, which in turn reflect expectations about future economic conditions and monetary policy. In this view, an inverted yield curve implies that investors expect lower interest rates at some point in the future when the Federal Reserve attempts to stimulate the economy and pull it out of recession. In that scenario, expected future short-term rates fall below current short-term rates, and the yield curve inverts.[9][10]
A related explanation holds that when investors who value interest income expect recession, a shift in Federal Reserve policy and lower interest rates, they try to lock in long-term yields to protect their income stream. The resulting demand for longer-term bonds drives up their prices, reducing long-term yields.[11]
Inverted yield curves outside the USA
 German bonds Inverted yield curve in 2008 and Negative interest rates 2014-2022 30 year 10 year 2 year 1 year 3 month |
 50 year 20 year 10 year 2 year 1 year 3 month 1 month |
 30 year 10 year 2 year 1 year 3 month 1 month |
 30 year bond 10 year bond 5 year bond 1 year bond 3 month bond |
 15 year bond 10 year bond 5 year bond 3 year bond |
 20 year bond 10 year bond 1 year bond 3 month bond |
 Inverted yield curve in the first half of 2022 during Sri Lankan economic crisis 15 year bonds 10 year bonds 5 year bonds 1 year bonds 6 month bonds |
 10 year bond 5 year bond 1 year bond |
 10 year bonds 5 year bonds 2 year bonds |
 Inverted yield curve in 1990 Zero interest-rate policy starting in 1995 Negative interest rate policy started in 2014 30 year 20 year 10 year 5 year 2 year 1 year |
 Inverted yield curve in 1994-1998 and 2004-2008 20 year 10 year 2 year 3 month 1 month |
See also
- Reference Rates. Federal Reserve Bank of New York.
- Here We Go Again: The Fed Is Causing Another Recession. Mises Institute. June 21, 2022.
- Austrian business cycle theory
- Friedman's k-percent rule
- Zero interest-rate policy
- 1970s commodities boom
- 2000s commodities boom
- 2020s commodities boom
- Yield Curve Control
References
- ^ "US Treasurys". CNBC. September 25, 2012.
- ^ Bodie, Zvi; Kane, Alex; Marcus, Alan J. (2010). Essentials of Investments (Eighth ed.). New York: McGraw-Hill Irwin. p. 315-317. ISBN 978-0-07-338240-1.
{{cite book}}: CS1 maint: multiple names: authors list (link) - ^ Bodie et al p. 318.
- ^ Rosenberg, Joshua and Maurer, Samuel. "Signal or Noise? Implications of the Term Premium for Recession Forecasting". Federal Reserve Bank of New York. Retrieved 27 May 2023.
{{cite web}}: CS1 maint: multiple names: authors list (link) - ^ "What Is an Inverted Yield Curve?". Investopedia.com.
- ^ Bruce-Lockhart, Chelsea; Lewis, Emma; Stubbington, Tommy. "An inverted yield curve: why investors are watching closely". Ig.ft.com.
- ^ Darian Woods; Adrian Ma (April 14, 2023). "An indicator that often points to recession could be giving a false signal this time". All Things Considered.
- ^ Campbell R. Harvey. "Yield Curve Inversions and Future Economic Growth" (PDF). Faculty.fuqua.duke.edu. Retrieved 26 July 2022.
- ^ Rosenberg and Maurer op cit.
- ^ Thau, Annette (2001). The Bond Book (Second ed.). New York: McGraw Hill. p. 86. ISBN 0-07-135862-5.
- ^ Thau op cit p. 87.
- ^ https://www.researchgate.net/figure/a-Irish-yield-curve-dynamics-around-2011-loan-amendments-b-Portuguese-yield-curve_fig2_342609297 [bare URL]