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The Inversion

Claus Vistesen profile picture
Claus Vistesen


  • Inverted yield curves - especially those driven by rapid shifts in short-term interest rates - tend to be interpreted as evidence of a risk that the Fed is about to hike the economy into recession.
  • The inverted yield curve today is the natural end-result of a long period during which inflation has been a lot higher than expected. This, in turn, has gradually but surely, driven short-term rate expectations higher, and shifted policymakers’ preference for acting sooner and more aggressively.
  • Until we see how bonds and equities absorb what will almost surely be a string of Fed hikes in Q2 and Q3, I’ll be keeping an open mind about what the inversion means, if anything.

Inverted Yield Curve with aerial view of New York City

Melpomenem/iStock via Getty Images

Your corresponding blogger has spent most of his time this week recovering from Covid, which has ruined some otherwise carefully laid plans for this week’s missive. I thought that I’d start slowly then, by dissecting the topic on

This article was written by

Claus Vistesen profile picture
Claus Vistesen is a Danish economist who specialises in macroeconomics. He holds a postgraduate degree in Economics. His primary research interests include demographics, macroeconomics and international finance which he practices as Chief Eurozone Economist for Pantheon Macroeconomics. His contributions at Seeking Alpha represent his views alone, and have nothing to do with his employer. He can be contacted through his e-mail (clausvistesen@gmail.com) or through his website (clausvistesen.com) where you can also find most of his writing. He enjoys the interaction with Seeking Alpha readership a lot and will try to reply to all of the comments you throw his way.

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Comments (1)

David de los Ángeles Buendía profile picture
Hello @Claus Vistesen ,

There is no "The Yield Curve". There are many yield curves. They are not all created equal.

Most economists, including the Federal Reserve Bank of Cleveland (FRBC), use the 10-Year Treasury Constant Maturity Minus 3-Month Treasury Constant Maturity (T10Y3M) curve [1]. The FRBC has an entire research arm dedicated to the assessment of the T10Y3M [2]. This yield curve is stable. It has not inverted.

The T10Y3M has historically peaked between 350 and 400 basis points (bp) usually two or three years after the inversion. It is just now only two years after the first inversion and the spread is only 185 bp[2]. This might suggest that yield curve has not yet peaked and a recession is not yet within the foreseeable future.

Credit and interest rates follow the Business Cycle. Generally longer term forms of credit pay more on interest then do shorter term forms. The spread between the interest on short term credit is high early in the Business Cycle as there is more demand for long-term credit early in the cycle and less demand later in the cycle. Demand for short term credit is more stable and does change as much.

More importantly, the market for long-term credit is very elastic while the market for short-term credit is very inelastic. As a result small changes in demand for short-term credit causes large changes in the price, i.e. the interest rate while the price of long term credit is much more stable. It is this difference in elasticity and volatility that accounts for the fact that the difference between interest rates for short term credit and long term credit peak just before a recovery and bottom-out just before a recession.

In some types of credit, this spread in yields over the term of the credit, that is to say, the Yield Curve, can even invert with short term forms of credit yielding higher interest than shorter term forms. The Yield Curve for some UST securities invert just before a recession but all yield curves are at a minimum before a recession.

Some yield curves have been shown to have inverted prior to a recession as far back as the 1890's, long before there was a central bank in the United States. The key element is the difference in elasticity between long term and short term interest rates and how changes in demand impact the price of credit over the Business Cycle.

[1] fred.stlouisfed.org/...
[2] www.clevelandfed.org/...
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