2019’s Inverted Yield Curve. What does this mean?

On March 22nd of this year, the U.S saw a a change the yield curve which is a very powerful indicator of a nearby recession. We saw it before 2007, and we are seeing it now. So what is a yield curve anyway? A yield curve is a measurement between fixed interest securities and time until maturity- the graph plots different interest rates along with maturity dates of those bonds. A “normal” yield curve represents higher maturity bonds having a longer yield than shorter maturity bonds and a “flat” yield curve indicates that the long-term and short-term yields are equal. And what does it mean when it is inverted? When a yield curve is inverted, shorter term yields are higher than longer term yields. This is considered bad because when short-term interest rates are exceeding long-term interest rates, the long-term view of the market is predicted to fall. Consumer borrowing is likely to fall, decreasing overall consumer spending and companies are likely to hesitate at the thought of expansion due to heightened expenses.

Inverted yield curves are considered relatively rare and although we just saw an inverted yield curve in late 2018 when the U.S. treasury rate peaked at just over 3%. The yield curve, inverted or normal, does not directly hurt or benefit the U.S. economy, it is just a predictor for what is going to occur in months time. The past handful of inverted yield curves in the U.S. have been followed by economic recessions such as in 1981, 1991, 2001, and was a main predictor of the 2008 financial crisis.

As of right now, we are uncertain if the recession following 2019’s inverted yield curve will be long or short, severe or moderate. What we do know is the Fed have learned a great deal since 2008 about raising and lowering interest rates based off the curve. Ten years ago, the Fed ignored the sign and instead of lowering interest rates, the idea that as long as long-term yields could provide enough liquidity, the economy would not face a recession. Hopefully, this time the Fed takes the right action to protect the U.S. economy.