One of the more important indicators to follow for a sense of where the global economy and financial markets are headed is the yield curve. It’s defined as the difference between yields on ten-year and two-year U.S. government bonds.
There are times when the two-year yield exceeds the ten-year yield – a condition known as the “inverted” yield curve. It doesn’t happen often but when it does, it historically has foreshadowed recession.
“Each of the past seven recessions was preceded by a brief period when the yield curve was inverted and there has only been one false signal,” says Financial Times of London columnist, John Authers.
The yield curve typically inverts when the Federal Reserve is trying to cool off a fast-growing economy by engineering an increase in short-term interest rates. Meanwhile, long-term rates stabilize, or even fall, as investors worry less about inflation and buy bonds to lock in rates.
When ten-year yields are above two-year yields, the curve is said to have a positive slope. Historically, the more the ten-year yield exceeds the two-year yield – i.e. the greater the positive slope — the more likely the economy and financial markets are headed higher.
The Federal Reserve will be trying to stimulate the economy with lower short-term rates while longer-term rates may be edging up because investors are buying fewer bonds due to concerns about inflation and rising rates (don’t want to lock in at low rates if higher rates are expected down the road).
Right now, the yield curve is very steep — at record levels, in fact. Last week, the ten-year Treasury yield stood above two-year Treasury yields by 2.94 percentage points, a spread never seen before since data collection began in 1976.
“Its previous peaks were at about 2.5 percentage points in October 2003, when a
