Last week, the spread between the 2-year and 10-year Treasury Notes contracted to 24 basis points, the slimmest margin in 11 years.
These two bonds comprise the most widely followed version of the yield curve. The yield curve plots interest rates, at a specified point in time, for bonds of equivalent credit quality but differing maturities.
This change in spreads, or flattening, is expected to continue. Typically, the yield curve slopes upward, as longer maturity issues offer higher interest rates. When shorter term issues have higher rates and the curve slopes downward, the yield curve is said to be inverted.
Yield curve inversion is troubling, as the yield curve has inverted prior to all of the nine recessions in the US since 1955. Currently, an inversion is just a quart of a point away. This leads market professionals to wonder whether we are headed for another recession.
There are varying opinions regarding the potential for an economic downturn. The San Francisco branch of the Federal Reserve recently stated: “Forecasting future economic developments is a tricky business, but the term spread has a strikingly accurate record for forecasting recessions. Periods with an inverted yield curve are reliably followed by economic slowdowns and almost always by a recession. While the current environment appears unique compared with recent economic history, statistical evidence suggests that the signal in the term spread is not diminished.”
So what’s going to happen if the curve inverts? Historical data shows that a recession comes on the average of 16 months subsequent to inversion and lasts around 12 months. For investors, this means that there’s time to take action and insulate portfolios against a downturn.
For more information, please read:
Is The Curve Yielding Economic Clues? | Wealth Management