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What an inverted Treasury yield curve means for the economy

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Inversions continue to happen in the yield curve. This Wall Street speak means that short-term fixed-income investments like bonds are paying more interest than comparable longer-term investments, something that hasn’t happened since 2007.

The three-month Treasury bill first inverted with the 10-year Treasury back in March. Toward the end of March, the 10-year Treasury returned to being higher than the three-month Treasury. But the two have been inverted since May 23. On Wednesday afternoon, the three-month Treasury was 2.34 percent and the 10-year Treasury was 2.23 percent, according to Bloomberg data.

“An inverted yield curve is a reliable, but not absolutely perfect, predictor of recessions,” says Mark Hamrick, senior economic analyst and Washington bureau chief at Bankrate. “With the economic expansion nearly at the 10-year mark, it should not surprise anyone that there’s a risk of an economic downturn at some point.”

If there is a recession or economic downturn in the future, it’s important to start planning now.

“For individuals who have the means to do so, they should stick to their financial game plan which ought to include paying down debt and saving for retirement and emergencies,” Hamrick says.

When the yield curve inverts – meaning a shorter-term Treasury bill has a higher yield than a long-term Treasury – it’s predicted every recession back to the late 1960s, says Greg McBride, CFA, Bankrate chief financial analyst.

Keep in mind that investors usually demand a higher rate of interest for locking up their money longer.

The first Treasury that people buy when risk increases is the 10-year Treasury, says Campbell Harvey, a professor of finance at Duke University.

“What is a safer investment than (the) 10-year Treasury? … When people start buying it, the price goes up, the yield goes down,” Harvey says. “So it’s just a great indicator in terms of kind of the perception of risk.”

The 10-year Treasury is at its lowest point this year, according to Bloomberg data and U.S. Department of the Treasury data.

Harvey says the recent inversion is a lead indicator of a potential recession.

It’s important to note that the media – and others – follow the spread between the two-year Treasury and the 10-year Treasury, which have flattened to a spread of around 14 basis points but haven’t inverted.

Why the 90-day Treasury may be a key Treasury to monitor

Harvey says he wrote his 1986 doctoral dissertation at the University of Chicago about the yield curve, focusing on the comparison between the spread between the five-year note and the 90-day Treasury bill. The latter length is key, because it equals the time in a quarter.

“So, there’s always a lead time. The lead time is empirically anywhere from three quarters to six quarters,” Harvey says.

But Harvey says that the yield curve inversion isn’t the only item on his watch list.

There are more economic indicators than just the yield curve

Harvey refers to these indicators as the four horsemen:

  • Duke CFO survey: 84 percent of U.S. CFOs surveyed believe a recession will have begun by the end of 2020.
  • Anti-growth trade policy: Brexit and the trade war between China and the U.S. fit into this category. “Unfortunately, downside risks have been exacerbated by rising trade tensions between the U.S. and China and lack of resolution of the Brexit quagmire,” Hamrick says.
  • Increased market volatility: “That’s essentially associated with people in corporations being more hesitant to make capital investment,” Harvey says.
  • Inverted yield curve: Gradually, the three-month Treasury bill has been surpassing longer-term Treasuries. For instance, the three-month Treasury bill and the five-year Treasury have been inverted since March 7, according to U.S. Department of the Treasury data.

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Written by
Matthew Goldberg
Consumer banking reporter
Matthew Goldberg is a consumer banking reporter at Bankrate. Matthew has been in financial services for more than a decade, in banking and insurance.