Jul 15, 2022 - Economy

The yield curve to watch with recession fears growing

Data: FactSet; Chart: Axios Visuals
Data: FactSet; Chart: Axios Visuals

You might have noticed chatter about inverted yield curves lately. It's now worth paying closer attention to.

Driving the news: Growing fears about inflation have hammered a key measure of the yield curve in recent days, pushing it suddenly much closer to "inversion" territory.

Why it matters: An inverted yield curve is often said to be one of the single best objective predictors of economic recession.

How it works: Roughly speaking, the yield curve is the difference in yields on U.S. government debt with different maturities.

  • When things are normal, short-term debt has a lower yield than longer-term debt — since the investor lending the money is taking on less risk.
  • But every now and then, the yield on shorter-term debt zooms higher than that of longer-term bonds — and that's an inverted yield curve.
  • There are many different versions of the yield curve. The most commonly cited one — the difference between two-year and 10-year Treasury notes — is already deeply inverted, and has been for a while.

The intrigue: But according to economists, that's not the iteration of the curve that actually has predictive power about the economy.

  • The one that does — the difference between three-month Treasury bills and 10-year notes — was looking pretty healthy until a few weeks ago. (This version of the curve was the one that was originally spotlighted as a great indicator by economist Campbell Harvey in the 1980s.)

Threat level: Since just the end of June, this crucial version of the yield curve has collapsed from roughly 1.6 percentage points to about 0.60 percentage points.

What to watch: If it falls below zero — thus inverting — and stays that way for about a month, it would suggest higher odds that we fall into a recession over the next 18 months.

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