| So what is going on? The yield on the 2-year Treasury note has been surpassing that of the 10-year bond—something frequently described as an inverted yield curve.
As investors tie up their money for a greater period of time with longer-dated bonds, they usually receive a more significant yield than those produced by bonds with shorter maturities. However, the relationship can sometimes invert—and many view this as a harbinger of a recession.
Over the past week, the yield curve has inverted at several points, however, at the time of this writing, the yield on the 2-year Treasury note was 2.50%, while the 10-year bond was yielding 2.56%.
Inversion of the 2-year and 10-year bonds has predicted past recessions—but it has not specified when these downturns would occur.
During the last six economic cycles, the average time between the yield curve's inversion and the start of a recession was roughly 18.5 months, Michael Reynolds and Jason Pride, who work for investment manager Glenmede, wrote in a recent note.
But while the headlines talk about the 2-year note, one research piece produced the Federal Reserve Bank of St. Louis took a different approach, comparing the 1-year note to the 10-year bond. The authors of this article emphasized the importance of harnessing real interest rates, meaning rates that are adjusted for inflation.
The real interest rate measures how quickly consumption is expected to increase over a given time frame, according to standard asset-pricing theory. Using this methodology, yield signals expected growth over the bond's maturity.
A positive difference between the 10-year and 1-year yield indicates an expected increase in the rate of expansion, while a negative difference points to growth slowing down.
As of this writing, the difference between the 10-year Treasury at 2.56% and the 12-month Treasury at 1.72% is 0.84%.
So is this time really different? Global economies are facing several challenges—record-high inflation, persistent supply chain issues, and labor shortages—as well as Russia’s invasion of Ukraine.
An inverted yield curve is a reliable indicator of an impending recession—and it's also subject to a wide range of interpretations, including the artificial depression of the 10-year yield due to the massive amount of pandemic stimulus.
Even Federal Reserve Chair Jerome Powell recently stated that he prefers to “look at the shorter part of the yield curve.”
Investors should keep yield curves in mind—and also recognize that as the economy shifts from mid-cycle to late-cycle, the period between an inversion and a recession could provide opportunities for investors. | 