What is a Yield Curve Inversion?

The yield curve inversion is big news if you are in the financial markets. In this week's blog, we take a look at the curve's recent changes and explain the meaning. 

Lisa Isaacson, Managing Director - Product & Marketing 

 

As of late, the financial media has been paying close attention to the shape of the Treasury yield curve. The current curve is inverted, and that inversion has been deepening. We have been talking about it in our weekly blog posts and you will hear several versions of the same story every day on financial news stations. In the simplest terms, an inverted yield curve means market demand for longer-dated Treasuries is higher than demand for shorter-dated Treasuries, driving yields down on the longer debt. Why would that be?  Basically, markets are expecting Federal Reserve (Fed) policy rates will be falling in the near future.

An upward-sloping yield curve is generally associated with a healthy economy on solid footing. Longer-dated Treasury bonds typically have higher yields than shorter-dated bonds to compensate investors for the additional interest rate risk of holding longer maturity bonds. An inverted yield curve turns that relationship upside-down and has historically been a reliable predictor of future recession.

Let's take a look graphically: last fall, the yield curve was upward-sloping. At year end, there was a slight inversion in two spots on the curve: one- to three-months and two- to five-years. This week, the curve is inverted from three-months out to three-years - and yields don't match three -month yields until you get out fifteen years.

 

 

Source: Bloomberg

 

Clearly, the market is expecting Fed policymakers will cut rates and is pricing those expectations into Treasury yields. It also suggests growing concern around current economic conditions is causing investors to become more risk averse and migrate assets toward risk-free Treasuries. Investor angst has increased due in large measure to President Trump's ramped-up use of tariffs to achieve his economic and political goals. How effective the Fed can be in countering the stifling economic effects of higher tariffs is debatable. But the yield curve is demanding they try.

 

Sources:

Bloomberg

Bureau of Labor Statistics