What is an inverted yield curve?
By Richard Leong and Dan Burns
March 22 (Reuters) - The inversion of the U.S. Treasury
yield curve extended to 3-month bills for the first time since
2007. Here is what that means.
WHAT ARE TREASURIES?
U.S. Treasuries are bonds, or debt, sold by the federal
government, most of which pay a fixed rate of interest over a
fixed period, ranging from one month to 30 years.
They are considered the world's safest securities because
they are backed by the full faith and credit of the U.S.
WHAT ARE TREASURY YIELDS?
Treasury yields are a measure of the annualized return an
investor can expect to receive for holding a government bond to
maturity. They also serve as a proxy for interest rates.
Yields are determined by the bond's price relative to its
stated interest rate. When bond prices rise, yields fall.
WHAT IS THE TREASURY YIELD CURVE?
It is a plot of the yields on all Treasury maturities
ranging from 1-month bills to 30-year bonds.
In normal circumstances, it has an arcing, upward slope
because bond investors expect to be compensated more for taking
on the added risk of owning bonds with longer maturities. So a
30-year bond typically yields more than a 1-month bill or 3-year
When yields further out on the curve are substantially
higher than those near the front, the curve is referred to as
"steep." So a 30-year bond will deliver a much higher yield than
a 2-year note.
When the gap, or "spread" in bond market lingo, is narrow,
it is referred to as a "flat curve." In that situation, a
10-year note, for instance, may offer only a modestly higher
yield than a 3-year note.
WHAT IS A CURVE INVERSION?
On rare occasions, some or all of the yield curve ceases to
be upward sloping. This occurs when shorter-dated yields are
higher than longer-dated ones and is called an "inversion."
On Friday, inversion of the yield curve hit 3-month T-bills
for the first time in about 12 years when the yield on 10-year
notes dropped below those for 3-month securities.
The curve overall has been flattening for some time. The
front-end to intermediate part of the curve inverted for the
first time in a decade back in December.
WHY DOES INVERSION MATTER?
Yield curve inversion is a classic signal that a recession
The U.S. curve has inverted before each recession in the
past 50 years. It offered a false signal just once in that time.
When short-term yields climb above longer-dated ones, it
signals short-term borrowing costs are more expensive than
longer-term loan costs.
Under these circumstances, companies often find it more
expensive to fund their operations and executives tend to temper
or shelve investments. Consumer borrowing costs also rise and
consumer spending, which accounts for more than two-thirds of
U.S. economic activity, slows.
The economy eventually contracts and unemployment rises.
HOW SOON DOES RECESSION OCCUR AFTER THE CURVE INVERTS?
The economy has taken anywhere from 12 to 24 months to fall
into recession when the yield curve inverts.
Also, the curve's inversion often ends before a recession
A yield curve inversion does not predict the length or
severity of a downturn.
WHY DOES THE CURVE INVERT AT ALL?
Shorter-dated securities are highly sensitive to interest
rate policy set by a central bank such as the U.S. Federal
Longer-dated securities are more influenced by investors'
expectations for future inflation because inflation is anathema
to bond holders.
So, when the Fed is raising rates, as it has been for three
years now, that pushes up yields on shorter-dated bonds at the
front of the curve. And when future inflation is seen as
contained, as it is now because higher borrowing costs are
expected to become a drag on the economy, investors are willing
to accept relatively modest yields on long-dated bonds at the
back end of the curve.
Friday's yield curve inversion between 3-month bill and
10-year note yields stemmed from a somewhat different set of
Longer-dated yields fell much more than shorter-dated ones
as investors scrambled to buy longer maturity Treasuries in a
safe-haven move in reaction to disappointing economic data on
Three-month bill yields slipped mildly as Fed policymakers
signaled no interest rate increases in 2019 two days earlier.
Separately, the Fed also announced a plan to end the
shrinkage of its bond holdings in September.
(Reporting by Dan Burns and Richard Leong; editing by Jonathan
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