The Yield Curve and Recessions

by Lisa Schreiber

The yield curve, as of June 2024, has been inverted for the most extended period in history. This is important because an inverted yield curve is said to be one of Wall Street’s most popular indicators of a coming recession. Below, we will take a closer look at what the yield curve is, what it tells us, and why it is said to forecast recessions.

What is the yield curve:

The yield curve shows the relationship between interest rates of bonds with different maturities, typically those issued by the government. The yield curve can provide insight into investor expectations about future economic conditions and interest rates.

Yield curve: Normal or Inverted:

  • Normal yield curve: In a normal yield curve, bonds with longer maturities have higher yields than shorter ones. This upward-sloping curve reflects investor expectations that the economy will grow, and interest rates will rise in the future.
  • Inverted yield curve: An inverted yield curve occurs when shorter-term bonds have higher yields than longer-term bonds, resulting in a downward-sloping curve. Inverted curves are less common and have been interpreted as a warning sign of a potential economic recession.

Source: Encyclopedia Britannica, Inc.

The yield curve, especially when inverted, has been closely monitored by economists and investors as a potential predictor of economic trends. Historically, an inverted yield curve has preceded all but one U.S. recessions since 1955. However, while it has been an indicator of past recessions, it is not infallible, and other factors and indicators should be considered when assessing overall economic health.

As of June 10, 2024, the yield curve has been inverted for 482 business days straight – a historical record. The last time it was inverted nearly as long was 419 days in 1980. This long stretch of inversion without a recession appearing makes some economists question the predictive nature of the yield curve. [1]

A common perception is that the initial inversion of the yield curve suggests a recession may arrive in the next 12-24 months. While the yield curve has been inverted for some time, and while the economy could contract in the coming months, current indicators outside the inverted yield curve reflect a different economic situation:

  • The US added 272,000 new jobs in May.
  • The unemployment rate still sits near historically low levels.[2]
  • US companies are growing their earnings.[3]
  • US inflation, while sticky – remains on a downward trend.[4]

Since the yield curve inverted, economists have been suggesting recession with varying levels of conviction (including, at one time, 100% of Bloomberg economists predicting a recession that did not occur). When looking at several other indicators of economic condition, it represents much more of a mixed bag than a clear signal that this inversion is predictive of a coming recession.

In conclusion, the yield curve serves as one indicator in the financial markets, and its shape can provide insight regarding the economic expectations of market participants. However, forecasting where the economy is headed is complex, and the yield curve and its shape should not be viewed as the sole predictor of the economic cycle.

At Gradient Investments, we constantly monitor various factors and indicators to evaluate the state of the economy and markets.  At this time, we do not see a recession occurring in 2024.  If economic indicators show a change in trend, we will communicate any shift in our outlook as we progress through the year.