If you’re a keen market observer, you would have read about the yield curve inverting which sent chills down the spine of investors globally. Financial and business news outlets were in a frenzy to point out that a key financial indicator was flashing warning signals that a recession is looming ahead.
Benchmark gauges surrendered gains back in March due to recessionary fears when the spread between the 3-month and 10-year Treasury note went negative for the first time this year since a decade ago. A pallid economic picture painted by the US Federal Reserve which downgraded its economic outlook and tilted its policy stance towards a more dovish approach also added to concerns.
But how accurate is the yield curve as a dark omen for markets that an imminent economic slump is coming for us all? Here is what you need to know about the yield curve and what bond markets are trying to tell investors.
Yield Curve Inversion, Explained…
Logically, people would demand higher interest rates for longer-term loans because the risk is higher over longer time horizons. Think about your fixed deposits (FD), where the longer your FD placement is with a bank, the higher your rate of return. So, a normal yield curve would have an upward slope indicating higher yields for longer-dated maturities.
A yield curve inverts when yields for longer-dated maturities fall below shorter-dated maturities. As mentioned earlier, the yield for the 10-year Treasury note dipped below the 3-month yield back in March’19 which is a rare occurrence in markets. This means that an investor is now getting paid more to hold shorter-dated maturities.