What is Yield Curve, and when does it become 'Inverted'?
The yield curve is a graph depicting yields on U.S. Treasury bonds at multiple maturities. Typically, it slopes upward, as short-term rates are lower than long-term rates as long-term investments attract additional risk premiums.
An inverted yield curve is a situation in which long-term rates are lower than short-term rates - suggesting that markets expect a recession, which will reduce interest rates in the near- to -mid-term.
Treasury Yield by Maturity in months
As shown in the chart, as of August 27, 2019, the yield curve was inverted as short term interest rates (1 and 2 month maturity) were higher than the long term rates (36-84 month maturity).
In this dashboard, we analyze how successful the inverted yield curve has been in predicting a recession.
The U.S. Federal Reserve’s preferred measure to gauge an inverted yield curve is the difference between the 10-year and 3-month
treasury yields. To ensure that short-term pressure on interest rates are excluded, the Fed considers the yield curve to have inverted only when the difference in yields for these two securities remains negative for ten consecutive days. However, we have used the difference between the 10-year and 2-year treasury securities
as the base for our analyses.The 10-year/2-year version of the yield curve has preceded each of the past five recessions, including the most recent slowdown between 2007 and 2009
For what proportion of the time gap has the yield curve been inverted historically?
Notably, the yield curve has been inverted for roughly 200 days during the gap before each of the last 4 recession. Because of this, the proportion was as high as 75% in the period after Sep 1980, just but was just 26% in the period after Jun 1998.
Proportion of Days During the Gap When Yield Curve Was Inverted [ A / (B*30) ]
Number of Days Yield Curve was Inverted During The Time Gap ( a )
Time Gap Between Yield Curve Inversion And Beginning of Recession ( b )
How Did The S&P 500 Fare During the Time Gap?
The S&P 500 usually does quite well during the time gap.
Peformance of S&P 500 During the Gap
During the time gap between inversion and recession, the performance of the S&P 500 has historically been robust
Moreover, during the 1988 gap, the index soared by more than 32% while during the most recent 2006 gap S&P 500 jumped by 16%.In other words, the S&P 500 index generally peaks after an inversion before the economy slumps into recession.On the flip-side, the S&P 500 gained during the first two recession cycles but the index lost more than 13% during 2001 recession and almost 35% during the 2008 crisis.
Peformance of S&P 500 During the recession