Inverted Yield Curve
Economists have discovered that an inverted yield curve could be a warning signal of a recession to come.
A what? A yield curve is a map of bond yields for different maturities — one month, three months, six months, 1, 2, 4, 7, 10 and all the way in between for 30 years. Generally, the borrower pays you extra for bonds with longer maturity to compensate you for the dangers of inflation and interest rate changes. For example, a 5-year bond should yield at least incrementally more compared to the yield of a 1-year bond.
Deviations from this hierarchy are infrequent — as it happens, nearly as uncommon as a recession itself. Interestingly, since 1955, long-term bonds yields were lower than short-term yields prior to each single U.S. economic downturn. Nobody knows precisely why a spate of marketplace illogic precedes economic troubles. There are theories, however, the cause/effect is unclear.
Historically, the inversions previously happened anywhere from 6 month to 24 months prior to the true recession, so there is not an exact time frame. But maybe we ought to think about another yield curve inversion as an opportunity to buckle our seat belts in the investment roller coaster.
Where exactly are we today? The chart found below shows the current yield in red, compared with a week ago in blue, a month ago in green, and a year ago in orange. As you may see, the curve has flattened in the previous 12 months, not necessarily to the point of inversion, but surely a thinner spread.