Yield Curves Near Inversion

On Tuesday, the front end of the yield curve inverted as 2-year yields rose above 5-year yields. Other front end curves, by that measure, while not there yet, have also begun to dip to cycle lows. The 10-year minus 3-month spread is at its lowest level since 2007. Despite being at a low for the current cycle, the curve remains around 40 bps from inversion.

In the charts below we look at various yield curves over the past 15 years; this time frame allows us to see the curve’s movement leading up to the last recession.

Perhaps the most widely followed curve, the 10-year versus the 2-year spread, is also at levels it has not seen since 2007. Although it is picking up slightly today as yields across the board fall, 2s10s is looking much more ominous at only 13 bps away from becoming inverted. This will be the main curve that investors will keep their eyes on; expect to see it ad nauseam in headlines if it moves those 13 bps lower.

Shifting our focus to the longer end of the curve, spreads are off of lows from earlier in the year, but may not have quite bottomed just yet. The 10-year versus the 5-year spread has recently fallen back down towards these lows.

Even longer maturities like the 30-year versus the 10-year have a higher spread still and has much more clearly made a bottom. It is important to note, leading up to the previous recession this curve was not inverted for long. Most of the bottoming occurred with a normal—albeit very flat—curve.

As we have noted in the past, while the yield curve has been a decent leading indicator of recessions and its warnings should be heeded with caution, just because an inversion may occur it does not necessarily mean that the sky is falling. A flat yield curve has historically even been a decent time for equities. Once again, yield curves are a leading indicator. As these curves become inverted there will likely still be some time before the next recession shows its face. But as always it will eventually come and forward returns will take a hit. In other words, contrary to the past few day’s price action, investors should not run to the hills just yet.

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