Inverted Yield Curve Hints at Recession
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
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.
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