Peering Around the (Yield) Curve

The 10-year vs. two-year US Treasury yield curve momentarily inverted, and many are worried about the negative signals this may send for risk assets and the economy at large. In the past, yield curve inversions have signaled increased odds of a recession, and sometimes, poor equity performance. However, to accurately assess the likelihood of these events requires a nuanced view of the details in conjunction with an analysis of the macroeconomic backdrop. We analyze why yield-curve slope measures can diverge and what the implications are for US recession risk, growth momentum, and equity performance.

Key Points

  • Understanding yield-curve signals: The Treasury yield curve captures expected government bond yields at different maturities. Usually there’s a clear relationship between expectations at one point and the next, but sometimes differences emerge during times of policy shifts.
  • Implications of yield-curve inversion:
    • Recession Risk: in our view, recession risk has increased, but it would be unusual merely given the steepness in the front end of the yield curve.
    • Growth Momentum: 10-year vs. two-year yield-curve inversions have typically been associated with growth slowdowns, which is in line with our view that growth will slow toward trend.
    • Equity Performance: equity performance has been mixed following 10-year vs. two-year yield-curve inversions. The inflation backdrop appears to be a differentiator here, and poses a headwind given our high inflation environment.
  • Multi-asset implications: our analysis warrants a nimble and cautious approach to risk assets. Recently, we have further reduced our preference for equities relative to fixed income.

Different Yield Curves, Different Signals

The 10-year vs. two-year Treasury yield-curve slope had momentarily inverted on March 31, but a shorter-term measure of yield-curve slope, proxied by the two-year vs. three-month, remains very steep. Why are these distinct yield-curve measures providing different signals? One key reason is that the two yield-curve slopes are measuring different aspects of policy.