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]
To determine whether the yield curve is inverted, it is a common practice to compare the yield on the 10-year U.S. Treasury bond to either a 2-year Treasury note or 3-month Treasury bill. If the 10-year bond yield is less than the 2-year or 3-month yield, the yield curve is inverted.[3][4]
History
The term "inverted yield curve" was coined by the Canadian economist Campbell Harvey in his 1986 PhD thesis at Duke University.
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 - for example, when the economy is expected to enter a recession and the Federal Reserve reduces interest rates 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.[5][6]
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.[7]
As a leading indicator
It has often been said that the inverted yield curve has been one of the most reliable leading indicators for economic recession during the post-World War 2 era. Proponents of this position maintain that inversion tends to predate a recession seven to 24 months in advance.[8][9][10][11][12] Others are skeptical, for example stating that the inverted yield curve is "not necessarily" a reliable metric for predicting recession, or that it has predicted "nine of the past five" recessions.[13][14]
In 2023, inversion during a labor shortage and low indebtedness raised questions over whether widespread awareness of its predictive power made it less predictive.[15]
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
- Daily yield curve data. U.S. Department of the Treasury.
- Daily yield spread data: 10-year vs. 2-year Treasury securities. Federal Reserve Bank of St. Louis.
- 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) - ^ Randall, David and Barbuscia, Davide (March 7, 2023). "Explainer: U.S. yield curve reaches deepest inversion since 1981: What is it telling us?". Reuters. Retrieved 27 May 2023.
{{cite news}}: CS1 maint: multiple names: authors list (link) - ^ Strauss, Lawrence C. "Yield-Curve Inversion Widens, Signaling More Recession Worries". Barron's. Dow Jones. Retrieved 28 May 2023.
- ^ 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.
- ^ 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) - ^ Campbell, Harvey R. "Yield Curve Inversions and Future Economic Growth" (PDF). Duke University. Retrieved 29 May 2023.
- ^ "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.
- ^ Thau op cit p. 86.
- ^ Andolfatto, David and Spewack, Andrew. "Does the Yield Curve Really Forecast Recession?". Federal Reserve Bank of St. Louis. Retrieved 27 May 2023.
{{cite web}}: CS1 maint: multiple names: authors list (link) - ^ 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.
- ^ https://www.researchgate.net/figure/a-Irish-yield-curve-dynamics-around-2011-loan-amendments-b-Portuguese-yield-curve_fig2_342609297 [bare URL]