Inverted Yield Curve
Quick Definition
A yield curve where short-term interest rates exceed long-term rates, often signaling an upcoming recession.
Key Takeaways
- Occurs when short-term yields exceed long-term yields
- Has preceded every U.S. recession since the 1950s
- The 2y/10y Treasury spread is the most watched indicator
- Duration of inversion matters more than the initial occurrence
What Is Inverted Yield Curve?
An inverted yield curve occurs when short-term Treasury securities offer higher yields than long-term ones, reversing the normal upward-sloping pattern. This phenomenon typically arises when the Federal Reserve raises short-term rates to combat inflation while investors, anticipating an economic slowdown, bid up long-term bond prices (driving their yields down). Historically, an inverted yield curve — particularly the 2-year/10-year Treasury spread turning negative — has preceded every U.S. recession since the 1950s, though with varying lead times of 6–24 months. While not a perfect predictor, it reflects market expectations that future economic conditions will be weaker than present ones.
Inverted Yield Curve Example
- 1In 2022, the 2-year Treasury yielded 4.7% while the 10-year yielded 3.5%, creating an inversion of about 120 basis points
- 2Banks borrow short-term and lend long-term, so an inverted curve squeezes their profit margins and can reduce lending
Related Terms
Yield Curve
A graphical representation of interest rates across different maturities for bonds of similar credit quality, typically U.S. Treasuries.
Treasury Bond (T-Bond)
A long-term U.S. government debt security with a maturity of 20 or 30 years, paying semiannual coupon interest.
Treasury Note (T-Note)
A medium-term U.S. government debt security with a maturity of 2 to 10 years, paying semiannual coupon interest.
Duration
A measure of a bond's price sensitivity to interest rate changes, expressed in years, indicating how much the price will move for a 1% change in rates.
Bond
A fixed-income debt security where investors loan money to an issuer in exchange for regular interest payments and return of principal at maturity.
Coupon Rate
The annual interest rate stated on a bond, expressed as a percentage of face value, that determines the periodic coupon payments.
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