Why Today’s Inverted Yield Curve Isn't Necessarily a Recession Warning

The most closely watched part of the US yield curve inverted this week for this first time since 2007, suggesting that a recession may be around the corner. We’re not convinced that’s true.

Don’t get us wrong, recession risks have increased over the last few quarters and investor caution is warranted. But while we expect the US and global economies to slow to their trend rate of growth, we’re not expecting contraction.

And while risk assets sold off sharply following the inversion, it’s important to keep things in perspective. Prior to Wednesday’s selloff, the S&P 500 index had risen by more than 18% this year.

What Does Inversion Tell Us?

The steepness of the yield curve refers to the gap between long- and short-term Treasury yields, and that gap has been narrowing for some time. But markets took notice anew on Wednesday when the yield on the two-year Treasury note rose above that on the benchmark 10-year note. The gap between these two securities is the most monitored part of the curve for good reason: Inversion here has preceded every US recession over the past 45 years.

But here’s something to keep in mind: While the US has never had a recession that wasn’t preceded by an inverted yield curve, not every curve inversion has been followed by a recession. And even when inversion did lead to recession, there has often been a significant time lag between the two (Display).

Not Your Typical Inversion

Let’s consider why the curve inverted this week. What we’ve seen is a flight-to-quality by the vast numbers of global investors looking to take refuge in US Treasuries, one of the safest parts of the global financial market.