The yield curve has been a fairly reliable indicator of recessions. But, first, let me clarify what the yield curve is.
The yield curve is simply the annualized yields of various treasuries that mature at different points in time. You can then plot those yields on a chart to visualize the “curve.”
For example, plot the annualized yields for a 3-month treasury on a chart, the 6-month, the 9-month, the 1-year, 2-year, 3-year, 5-year and so on out until the 30-year maturity. Then you connect the dots and it creates a “curve,” much like the sample below.
The curve is usually upward sloping. After all, it makes sense that lenders would require a higher interest rate on longer-term loans.
However, occasionally, the yield curve “inverts” meaning the short-term maturities have higher yields than the longer-term maturities. And THAT is the current state of the yield curve (pictured below).
I made a well-received video about the inverted yield curve here.
Another way to visualize the yield curve is to subtract the 3-month treasury yield from the 10-year treasury yield then plot that difference on a chart.
When the difference is greater than 0% the yield curve is upward sloping. When the difference is negative (i.e. 3-month yields MORE than the 10-year) that’s an inverted yield curve.
The shaded regions on the chart below are recessions. Now we’re getting to the meat of it. You can see there is a relationship between the yield curve and recessions. Recessions tend to follow yield curve inversions (i.e. when the 3-month treasury yield exceeds the 10-year treasury yield).
We’ll also notice that today’s yield curve is more steeply inverted than it’s been since at least 1970 and perhaps in all of American history.
I was curious to know what the average duration is between yield curve inversion and recession. See below…
*Note that for the chart above I defined “yield curve inversion” as a -0.2% inversion for at least a month.
On average, recessions began about 8 months after yield curve inversion with a range of 3 to 15 months afterwards. That would imply recession most likely begins sometime in 2023 if history were to repeat here (no guarantee history repeats obviously).
The stock market peaks relative to yield curve inversions are all over the place. Sometimes the stock market peaks in advance of yield curve inversion and other times it peaks well after. At this point, the stock market peaked in January of last year, or about 16 months ago while the yield curve inverted about five months ago.
Past performance is no guarantee of future results. All investments maintain risk of loss in addition to gain.
Data from third-parties is believed to be reliable but accuracy is not guaranteed. Much of the data used to interpret the markets and forecast returns are often at odds with each other and can result in different conclusions. Many different factors impact prices including factors not mentioned here.
This is not investment advice but merely a general commentary. Individualized investment advice cannot be provided until a thorough review of your unique circumstances and financial goals is completed.
Views provided here are current only as of the moment of posting and are subject to change at any time without notification.