Inverted Yield Curve Hints at Recession

Chart of 3-Year and 5-Year Treasury Note Yields - Inverted Yield Curve

In an epic turnaround on Tuesday, markets dropped sharply after having rallied a day earlier to begin the month of December.

Was Tuesday’s plunge a sign of low confidence that an eventual U.S.-China trade war can be averted, despite seemingly optimistic Trump-Xi talks? Or were jitters about a slowing global economy to blame for the market slide? Or was it both?

Yield Curve Inverted

From the economy’s perspective, this week saw the 3-year and 5-year Treasury note yields invert for the first time since 2007.

But what does this actually mean? To explain it very briefly, a yield curve is considered inverted when longer-term debt has a lower yield than shorter-term debt. When this happens, it’s often considered a foreboding sign of impending recession. The onset of such a recession can sometimes range from several months to a couple of years after a yield curve inverts.

The chart above clearly shows that a slight inversion of the 3- and 5-year yield curve has occurred this week. That is, the 3-year yield is now above the 5-year yield.

Don’t Panic … Yet

Now, before anyone gets too distressed about this, it should be noted that when most economists and investors warn about inverted yield curves, they’re most often talking about the 2-year and 10-year notes. And not the 3- and 5-year. That said, though the 2- and 10-year note yields have not yet become inverted, the spread between the two is the narrowest since 2007. This means that an impending inversion is a clear possibility potentially on the horizon.

While this is not meant to raise any premature red flags, perhaps it should be a warning that now may be the time for many investors who haven’t done so already to become less complacent and more vigilant in proactively managing their investment risk.


IMPORTANT: The information above should not be construed as investment advice and should not be considered as a solicitation to buy or sell securities. Past performance is not indicative of future results. Trading and investing in the financial markets involves substantial risk of loss, and may not be suitable for all investors.

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