The Yield Curve Steepens Again: Signal of a Recession or Expansion?

By Samantha MulveyThe yield curve, a historically reliable recession indicator, has reversed over the past few weeks. So while this means that the economy is no longer in immediate danger, the jury’s still out over whether there is still trouble to come in the next few years. The yield curve is the difference between interest rates on long-term government bonds and short-term government bonds. Normally, it is a positive difference since the rate of return on a long-term bond should naturally be higher than that of a shorter-term one so as to incentivize investors to lend money to the government for more time. But, sometimes, this yield curve flips or becomes “inverted.” An inverted curve suggests slower economic growth since it means investors are reluctant to invest in the bond market. It is also one of the most dependable recession indicators. Every recession over the past six decades began with an inverted yield curve. In regards to recent yield curve activity, it finally corrected itself, or “steepened,” on October 11 after being inverted on and off since March; during this period it had been consistently inverted since July. On November 8, the yields on the 10-year Treasury note hit its highest level since July.This positive change in an economic indicator sits among a mixed bag of other signals. Trade has still been slowing and manufacturing has been shrinking, while the job market has been doing well and corporate profits were higher than expected this past quarter. On the other hand, even though the yield curve has righted itself, some argue it doesn’t mean a recession is completely out of the question. In fact, it could mean just the opposite. Historically, it has taken up to two years for a recession to come after an inversion. Additionally, a subsequent steepening after such an inversion could just be further evidence of an imminent economic downturn. Over the past 40 years, a re-steepened yield curve often spelled economic trouble, except for successful rate cuts in 1998 that prevented a possible downturn, which is good news.While history suggests that the yield curve’s inversion and subsequent steepening foreshadow a recession, there is something different about the course of events this time around. The yield curve first inverted in March and, starting in July, the Fed began cutting rates which it did three times. Before the most recent recession of 2008, the yield curve first inverted in 2006 and it took the Fed a full year before it began to cut rates. So maybe the Fed’s more proactive reaction this time around will mirror the course of events in 1998 so as to avoid the possible recession everyone’s been dreading.Sources: https://www.nytimes.com/2019/11/08/business/yield-curve-recession-indicator.htmlhttps://www.treasury.gov/resource-center/data-chart-center/interest-rates/pages/TextView.aspx?data=yieldYear&year=2019https://www.cnbc.com/2019/10/19/why-the-yield-curves-steepening-may-not-actually-be-a-good-sign.htm