The Garrulous Jay – Curve Ball

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Over the last week I’ve had a couple of press articles drawn to my attention about the inversion of the US yield curve, and been asked whether investors should be worried about this as a harbinger of recession.

Many of you will know exactly what I’m referring to, but for those of you wondering what on earth the ‘yield curve’ even is, a bit of explanation… The yield curve usually refers to a chart that plots along it’s x-axis government securities (such as US Treasuries) by their duration, whilst the y-axis shows the yield (or interest rate) on those securities.

In ‘normal times’ the yield curve slopes upwards from left to right, so the longer the time to the maturity of the Treasury instrument, the higher the return available to investors. In very simple terms this is because investors seek a higher return for locking their money away for longer.

From time to time, however, the yield curve ‘inverts’. In other words, the yield on shorter duration Treasuries is higher than that on their longer-dated equivalents, and that’s where we are today.

For example, the yield on two-year Treasuries is currently 4.99%, where as it’s 4.58% on the ten-years (Source:

Historically many economists have pointed to this as a signal of impending US recession. A 2018 paper published by the Federal Reserve Bank of San Francisco stated, for example, that every US recession between January 1955 and February 2018 was preceded by an inversion of the yield curve.

And here we are again.

Time to sell, right? Wrong!

For a start, it is by no means universally accepted that yield curve inversion is as reliable a predictor as some argue. One reason for this might be that the inversion can be affected by either the short end rising – driven by US Fed monetary policy – or the long end falling, perhaps due to high demand.

Assuming, however, that it is a reliable indicator, I think one should ask, “so what”? The US yield curve is not exactly a secret: in fact, it’s probably one of the most widely followed charts in global finance.

From this one should conclude that future expectations for the US economy, as signalled by the shape of the US yield curve, are highly likely to be reflected in asset prices already.

But even if this isn’t the case and the market is surprised by a US recession next year, the question that then needs to be asked is this: what will markets be pricing in next year when the recession hits? Will it be the recession itself or, perhaps, the future recovery that will follow? I would argue the latter: the markets always look forward, not sideways.

And finally, recessions come in different shapes and sizes. There is a world of difference between a short and shallow ‘technical’ recession, compared to a prolonged and deep recession.

So for investors, by the time the papers are talking about the inversion of the yield curve it’s probably too late to be useful…if it ever is.