Inverted Yield Curves

Upside down
Boy, you turn me
Inside out
And round and round
--Diana Ross

This past week the yield on two-year Treasuries exceeded the yield on ten-year Treasuries. This is unusual. Normally investors demand higher interest rates on longer dated debt. When the yield relationship flips over, or 'inverts,' it often seen as a harbinger of forthcoming economic recession.

Indeed, a review of past occurrences of inversions between 'twos and tens' suggests a good predictive track record. Even if the relationship subsequently 'un-inverts' (which it often does), recession appears imminent.

However, it should be noted that many maturities comprise the complete Treasury yield curve--beginning with 1-3 month T-bills all the way out to 30 yr Treasury bonds. Currently, only the twos and tens relationship is upside down. 

For example, the spread between 12 month and 10 year Treasuries has yet to invert. Yet, note that the 12 month/10 yr relationship has also been a good predictor of recession.

What this suggests is that the relationship between twos and tens, and subsequent recession may be a spurious one when viewed in isolation. The recessionary signal sent by the inversion phenomenon is likely stronger when more of the yield curve joins in. 

Consequently, look for shorter duration yields to continue rising relative to long duration yields before confidently concluding that the inverted yield curve/recession warning is in play.