Who’s afraid of an inverted yield curve

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There seems to be a lot of fear around about the prospect of the US yield curve inverting. Hardly a day goes by without another article speculating about when the curve might invert and what might happen if it does. Given that an inverted yield curve is widely regarded as a predictor of recession, it is not difficult to understand why people are concerned – but it is also worth taking a step back from the headlines to try to understand what an inverted yield curve actually tells us, and what it doesn’t. Let’s tackle the most important question first: is an inverted yield curve a reliable predictor of a recession? Generally, yes – but perhaps not exactly in the way that people think. Inverted yield curves do not cause recessions. They are, however, a good indication of the relative tightness of monetary policy, which impacts on the real economy over time. Data shows that the past five recessions since 1976 were all preceded by an inverted yield curve, and the inversion persisted for a prolonged period of time (typically at least 10 months). The yield curves then re-steepened prior to the recession in each case.