The U.S. Yield Curve Has Inverted

A quick explanation in layman&#x27;s terms:<p>I have money on hand and I want to put it into something safe. The US government is constitutionally bound to pay its debts, and is generally considered to be very safe (if not the <i>safest</i> investment around).<p>The US government sells bonds with different terms. I can buy 1 year bonds, 3 year bonds, 5 year bonds, 10 year bonds, etc. The treasury sets a fixed interest rate and face value on treasury notes and then whoever pays the most gets the note.<p>Right now, (annualized) rates [1] are approximately as follows:<p>1 month - 2.30% 6 month - 2.56% 1 year - 2.72% 3 year - 2.84% 5 year - 2.83% 7 year - 2.90% 10 year - 2.98%<p>Notice that the 3 year rates are higher than the 5 year rates. Generally speaking, if I&#x27;m going to lock up my money for more time, I expect a higher return. However, today, the 3 year notes are getting a higher rate of return than the 5 year notes. Why?<p>Interest rates generally tend to follow the economy at large. When the economy is doing well, people will invest in stocks and other investments and are less willing to pay for the safety of treasuries, so effective rates go up when people bid less at treasury auctions (additionally, the government will take steps via the Federal Reserve to make rates higher). By the same token, when the economy isn&#x27;t doing well, people want the safety of treasuries, even if they pay less, so effective rates on treasuries tend to go down.<p>In rare cases, the yield curve will invert. What this means is that investors think that rates of return on government bonds are going to go down in the future. In order to lock in a better rate now, they&#x27;re willing to pay more for longer term bonds (in this case, 5 year bonds vs. 3 year bonds) in order to &quot;lock-in&quot; the good rates. The assumption is that they won&#x27;t be able to get the same good rates if they don&#x27;t act now.<p>Note that only the 3 and 5 years have inverted. If people were really panicked, you would probably see a more significant inversion, where for example, the 1 year was higher than the 2 year and the 2 higher than the 3, etc.<p>[1] these rates are actual rates of return calculated based on the auction price paid

There is a 1 bps spread between the 3-year and 5-year US Treasury (2.84 vs 2.83) as of close of market today.<p>While somewhat noteworthy, it&#x27;s not huge (yet). When people talk about yield curve inversion and it being an indicator of recessions, it&#x27;s much more common to compare the 2-year with the 10-year. Currently that sits at 2.83 (2yr) vs 2.98 (10yr). While the shorter spreads do often invert first, there is no requirement for the longer spreads to follow.

<i>Banks borrow short and lend long</i>.<p>Meaning they take short-term deposits (e.g. current account balances) and make long-term loans (e.g. mortgages). They normally make a profit, because they borrow short paying low rates, and lend long receiving high rates. Easy. Head to the golf course.<p>If the yield curve inverts, banks lose money ... their capital ratios and share prices fall ... they become more risky and less creditworthy ... people withdraw their money ... bank runs, ATMs stop working, bail-ins ... your current account is <i>permanently unavailable</i> (see Cyprus, Greece).<p>Note that many banks, especially European banks, are starting from an existing almost-bankrupt state, with plummeting share prices (DB, UniCredit, BBVA, BNP). If the EUR yield curve inverts, they all crash faster than an anvil without a parachute (DB is already giving the anvil a good race).

Can someone explain this in dumb person language? All I get is that the yield that bonds give is below zero, meaning you lose money holding them? And bonds are buying debt on faith the issuer will pay, and as the issuer pays, you get dividends.<p>And I think the interest rate is inversely proportional to the amount the bonds pay or something like that?<p>Just explain in simple language. :)

So I read the article but I don&#x27;t quite get it.<p>A 5-year bond now has a lower yield than a 3-year bond? How is that even possible? Wouldn&#x27;t anyone who wants a 5-year bond just buy a 3-year bond and then put the cash under their mattress after 3 years?<p>Is the idea that in 3 years&#x27; time, negative interest rates will be widespread, physical cash will be abolished, and figuratively keeping the cash under your mattress isn&#x27;t even possible?<p>EDIT: And why don&#x27;t arbitrageurs buy up 3-year bonds and sell 5-year bonds?

If anyone is curious how this has compared over time for more context, this is a great visual tool to graph&#x2F;animate the yield curve:<p><a href="https:&#x2F;&#x2F;stockcharts.com&#x2F;freecharts&#x2F;yieldcurve.php" rel="nofollow">https:&#x2F;&#x2F;stockcharts.com&#x2F;freecharts&#x2F;yieldcurve.php</a>

Worth noting that unlike previous business cycles the Fed is manipulating both the long and short end of the curve. Quantitative Tightening (QT) is the Fed&#x27;s program to sell and&#x2F;or let expire the long-term Treasuries it bought during QE 1&#x2F;2&#x2F;3.<p>As the same time, the Fed is raising short term interest rates using its tried-and true headline short-term interest rate target.<p>This is not just unusual - it&#x27;s unprecedented. QT has the effect of suppressing the yield curve inversion signal (by artificially increasing long-term rates). As a result, the gap between the next yield curve inversion (the one mentioned in the article hardly qualifies) and the next recession could be surprisingly short.<p>Backing off now on QT and short term raising, with unemployment at a very low point and inflation ramping up, would be lethal to the Fed&#x27;s credibility. Whatever Powell says to try to talk the stock market up, he&#x27;s locked and loaded and can&#x27;t do much beyond stick with the program: triggering the next recession.

Fans of Planet Money’s “The Indicator” are no doubt imagining Cardiff prepping new yield curve material.

Question: Are there any other recession signals which have also recently presented themselves? I know very low unemployment, which we have, is one. Are there others?

a better way to understand the causality between yield curves and recessions is to look at it from the perspective of the banking sector ... banks&#x2F;lenders primarily borrow short-term and lend long-term. They pay depositors short-term rates and earn the long term rates on loans. If this carry trade turns negative, it makes it difficult to make money lending, they get more conservative and collectively they tighten credit conditions on the economy as whole.

&gt; All it means is that the central bank will probably leave interest rates steady, or even cut a bit, in 2022 or 2023.<p>This event reflects the relative preference of the markets for the 5 yrs compared to 3 yrs, producing lower effective yields. This is probably done to secure a certain rate for a longer period of time.

One thing I&#x27;m interested to see if anyone can discuss what&#x27;s different this time (i.e, Fed has ~4x more assets on it&#x27;s balance sheet [and the roll-offs], corporate have ~2x more debt, labor force participation rate is at levels not seen since the 60&#x27;s, 4 eurodollar &quot;events&quot; since, US gov debt levels since) and how it could theoretically affect the yield gymnastics?<p>Some banks keep saying 2020 is the big one since that&#x27;s when most of the corporate debt will be need to rolled over onto higher rates, but I&#x27;m of the mind we don&#x27;t even make it that far because of even shorter term liabilities (think corporate buybacks with debt at higher rates that will increasingly put pressure on balance sheets m&#x2F;m, liquidity pressure risk assets, devaluation on collateral) in this environment.

It doesn&#x27;t have to be this way. The curve was unnaturally flat to start with due to Operation Twist. As the Fed unwinds its balance sheet, it seems only naturally to also unwind the effects of Operation Twist at the same time.

Can someone concisely explain what yield curve inversion could indicate?<p>I can think of a few explanations for why long term yields are going lower:<p>1. Long term yields going lower because there are far fewer places for capital to go to besides US treasuries, indicating slower business activity<p>2. Short term yields going higher because no one wants to buy short-term treasuries because there&#x27;s something else to invest in or expect higher return for short term investment?<p>Are these the only two reasons? Why are people so fearful of inverted yield curves?

All those Princeton and Harvard economists travelling the world telling foreign governments how to run their economy lol. Does any politician in the US even read the emails the Fed sends them? Must be the most thankless job ever.

Interesting use of the Smiler RollerCoaster in the lead photo. It was involved in a serious crash a few years ago.

Is this a result (in part or more) of setting a schedule for fed funds rate increases and sticking to it?

Based on past patterns, we now have about 15 months before a formal recession is declared. This is rough and imperfect, but many other metrics are pointing to both the end of the bull market and a coming recession. I&#x27;ve been monitoring the econ because I plan to invest in real-estate and stocks during the next slump. [Corrected &quot;bear&quot; typo.]

This is not the typical yield spread a practitioner or the fed would look at.

Inverted yield curve has predicted 10 of the last 3 recessions

Is it Good or Bad? And in what way?

so there is starting to begin some panic but its not in full swing yet.