Despite Apple topping $1 trillion in market value, the unemployment rate continuing to climb down, and a multitude of other positive market indicators, the Treasury yield curve has begun worrying some market analysts. That said, we don’t feel that investors should worry too much about an inverted yield curve. Here’s why…
The Treasury Yield Curve as an Indicator of Recession
The Treasury yield curve is typically upward sloping where long-term yields are higher than short-term yields. The longer the time to maturity, the higher the risk to the bondholder since the longer-term bonds have a longer time horizon and are therefore exposed to more potential changes in interest rates than short-term bonds. This forces investors in long term bonds to seek higher yields in exchange for accepting the added risk of a longer maturity bond.
What is the Treasury yield curve? The U.S. Treasury Yield Curve compares the yields of short-term Treasury bills (those with terms of less than a year) with long-term Treasure notes and bonds (notes have terms of two, three, five, and 10 years while bonds have terms of 20 or 30 years). Yields always move in the opposite direction of Treasury bond prices because low demand drives the price below the face value while high demand drives the price above face value.
The yield curve becomes inverted when short-term yields are higher than long-term yields. An inverted yield curve does not happen very often, but it has preceded every recession in the U.S. for the last 50 years.1