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- Two years of yield curve inversion in the U.S.
Next Friday, July 5th marks an anniversary: the U.S. yield curve will have been inverted in the two- to ten-year range for two years. This inversion, often seen as a recession warning, is the longest ever in this duration.[1] The inversion was at its deepest in July 2023, at around 108 basis points. Currently, the difference between the two- and ten-year yields is just around 50 basis points.
The inversion of a yield curve means that short-term debt instruments offer higher yields than their long-term counterparts from the same issuer and of the same credit quality. In the U.S. we typically look at U.S. Treasuries. An inverted curve generally indicates that investors are willing to accept lower yields for long-term bonds. This is seen, among other things, as a sign of growth fears. But an inverted yield curve is also inherently bad for economic activity, as higher short-term yields increase borrowing costs for consumer and business loans, while the lower level for longer maturities reduces risk appetite. For this reason, yield curve inversion has historically been considered a reliable recession indicator. This time, however, the recession fear does not seem to be materializing.
Historically, it has taken an average of 12 months from a U.S. yield curve inversion to recession
Sources: Statista, DWS Investment GmbH as of 6/25/24
Over the past five decades, it has taken an average of twelve months for a recession to occur after the first day of the inversion of the U.S. yield curve. As seen in the chart, these periods vary significantly, between 22 and just six months.[2] Currently, however, although there are noticeable signs of weakness in several areas of the U.S. economy, the general trend does not seem weak enough to be the precursor to recession.
In our view, in fact, widely spread recession fears have acted to help prevent recession this time. Many companies seem to have proactively reduced their surpluses to survive the expected lean times ahead. As a result, they have been better able to help prevent an economic downturn. Growth sectors, in particular, have even been able to finance their expansion by using their well-filled balance sheets. Additionally, financing conditions in the U.S. have remained extremely favorable during the past two years. U.S. banks have also been able to continue offering attractive lending conditions despite the Federal Reserve’s (Fed) rate hikes.
We see the current inversion of the yield curve in the U.S. more as a sign that the old growth “boom times” will not return so quickly. But this does not mean future inversions should be ignored: next time the recession warning light could prove correct.
