Today’s Yield Curve Steepening Is Not Different This Time, It’s Not The Same

Investment volatility remained elevated this year. One can point to any number of culprits. My preferred cause has been interest rate volatility. I’ve been cautious as the Federal Reserve (Fed) raised its benchmark rate. However, a popular risk indicator has recently been sending a mixed message. The yield curve has been steepening. Thus, the investment environment might be changing, requiring different portfolio positioning. Upon further examination, though, I find myself pondering the most dangerous investment thoughts possible: Could this time be different?

As far as investment signals go, it’s hard to beat the shape of the yield curve. It’s one of the most studied and reliable recessionary indicators. While the yield curve’s October 2022 inversion captured much attention, so too has its rapid steepening. However, a look under the hood reveals that it might not be the call-to-action signal for which I was waiting.

Inversions and recessions

Economists have long studied the relationship between the shape of the yield curve and economic performance in the U.S. While specific curve choices vary, they typically compare yields for the 3-month U.S. Treasury bill (3mUST) to the 10-year U.S. Treasury note (10yUST). Normally, this curve is positively sloped, exhibiting a “term premium” whereby longer-dated bonds yield more than shorter-dated ones. However, on rare occasion it inverts such that the 3mUST yields more than the 10yUST. When these occur recessions typically follow making them noteworthy events.