As volatility increases, many of us are starting to wonder when the next recession will hit us. One of the markers of past recessions is an inversion of the yield curve, meaning when long-term rates drop below short-term rates. And it seems this is where we are heading, as most recently, the long-term spreads have both continued their decline.


Source : "Information in the Yield Curve about Future Recessions", Federal Reserve Bank of San Francisco


The graph shows the evolution since 2000 of three spreads - the difference between the ten-year and three-month Treasury; the ten-year and 2-year Treasury, and between the six-quarters-ahead forward rate and the three-month yield (forward6q–3m). They typically drop below zero, indicating an inversion of the yield curve, about a year or two before the onset of a recession. 

“When the Federal Reserve repeatedly raises rates, as it’s been doing for the past two years, the normally upward-sloping yield curve may flatten out or even invert,” explains Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “And that makes many people nervous, because an inverted yield curve has preceded every modern recession.”

She states that if an inversion was to occur, which has not happened yet,  it doesn’t automatically augur a recession. “In fact, the yield curve has sent a number of false signals, most recently in June 1998, when no recession came to pass despite the curve’s brief inversion.”

She concludes: “the yield curve is something to keep an eye on, to be sure. But if other economic indicators are strong, it’s not worth losing sleep over.”