Why you shouldn’t freak out about the yield curve “uninverting”

The spread between the 2 and 10-year US Treasury yields briefly flipped back into positive territory on Wednesday for the second time since 2022 after some mildly concerning data on the US job market.

That is, the interest payment you’d get from owning a 10-year Treasury was once again higher than what you’d get by owning its shorter-maturity 2-year counterpart.

Normally, so-called yield curves are upward-sloping. That’s (in part) because theoretically you should get extra compensation for parting with your money for a longer period of time.

Here is one person to not listen to about the implications of the 2s10s curve briefly un-inverting:

Strangely, here is another person to not listen to about the matter (who has managed billions more in bonds than I ever have, for what it’s worth):

(Irony. You keep using that word. I do not think it means what you think it means.)

When the yield curve inverts and shorter-maturity US government obligations yield more than longer-term bonds, that’s a signal that the market expects a stretch of central bank tightening to slow the economy and bring down inflationary pressures. This can sometimes, but not always, be the proximate cause of a recession.

When the 2s10s curve un-inverts, this is a signal that the central bank is expected to be cutting rates over the near-to-medium term. Historically, this un-inversion of the curve has been a recession signal, because monetary policy policy easing has often come too late to avoid an economic downturn. But not always! And our sample size isn’t large enough to take that fatalistic a view here or to consider this to be some kind of economic law of nature.

The movements of the yield curve largely tell you what the central bank is expected to be doing. The link between what traders think a central bank will do and what the economy actually does is tenuous.