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The yield curve briefly inverted this past week—and that’s a recession signal that is either like Paul Revere’s ride or the boy who cried wolf. The good news: Investors don’t need to decide which just yet.
The yield curve refers to the difference in yields between differing maturities of Treasuries. Normally, short-term bills, with maturities measured in weeks or months, pay less interest than longer-term notes and bonds, leading to an upward-sloping curve. Sometimes, though, longer-term yields are lower than shorter-term rates, an inversion that often signals a looming recession.
Not all inversions carry the same weight. The yield on the five-year Treasury recently rose above the 30-year, which offers little in the way of information. The two-year yield rising above the 10-year, however, has historically been a sign that an economic slowdown is coming, though still months away. That happened this past week, when the two-year closed at 2.43% while the 10-year closed at 2.374%.
No need to freak out just yet. While the first inversion gets all the attention, it’s the second one they need to worry about, says Nicholas Colas, co-founder of DataTrek Research. He notes that the yield curve often inverts, then returns to its normal shape before inverting again. The inversion doesn’t cause the recession. Instead, it’s simply a sign that the economy is fragile enough for an outside event to trigger a slowdown. That was the case in 2001, when the popping of the dot-com bubble and 9/11 caused the recession, and in 1990, when Iraq’s invasion of Kuwait did. “Inverted curves…