Visualizing (and Understanding) an Inverted Yield Curve

For a few months in 2019, the yield curve inverted and warned of a potential recession.

Towards the end of 2021, it happened again. And throughout 2022, the inverted yield curve has looked more and more extreme. So what does an inverted yield curve look like, and what does it signal about an economy?

The above visualization from James Eagle shows the yield curve from November 2021-2022 using eurodollar futures yields—which serve as an indicator for the direction of the yield curve.

What Denotes an Inverted Yield Curve?

Generally speaking, the yield curve is a line chart that plots interest rates for bonds that have equal credit quality, but different maturity dates.

In normal economic conditions, investors are rewarded with higher interest rates for holding bonds over longer time periods, resulting in an upward sloping yield curve. This is because these longer returns factor in the risk of inflation or default over time.

So when interest rates on long-term bonds fall lower than those of short-term bonds, it results in an inverted yield curve.

The worrying trend is that an inverted yield curve in key government securities such as U.S. Treasuries can often foreshadow a recession. For every recession since 1960, an inverted yield curve took place roughly a year before, with just one exception in the mid-1960s.

This is because the yield curve has steep implications for financial markets. If the market predicts economic turbulence, and that interest rates (Read more...)