It didn't last long. On Friday, April 1—yes, April Fool's Day—the bond yield curve went inverted, meaning that the return on a 2-year U.S. Treasury security was greater than on a 10-year bond.
A few days later, the yield curve reversed itself, but not before the anomaly made headlines and caught the eye of economists as a potential harbinger of a recession.
The inversion, which only lasted a few days, shouldn't come as a surprise or be a cause for panic, said Steve Wyett, chief investment strategist for BOK Financial®.
"We've seen the headlines, we all knew the elements were present," he said. "It's a bright flashing, yellow light, not a solid red beam. It's the caution signal that it's highly likely a recession is on the horizon, but we don't know when."
What's in a yield curve?
Technically, a yield curve is merely a plot of the returns that are available on U.S. Treasury securities of different maturities. The slope of a yield curve provides insight into future interest rate changes and economic activity because the U.S. Treasury funds our economy.
Simply, the yield curve plots what a return would be at a specific point in time. But it is also an indication of how bond investors are feeling about the future state of the economy.
Yield curves come in three varieties: Normal (upward sloping), inverted (downward sloping) and flat.
"An inverted yield curve is unnatural because it means as an investor I can earn more buying a two-year treasury than a 10-year," Wyett explained. "Which is opposite of the normal, where longer-term means higher return because it's higher risk."
This isn't the first time the yield has changed its curve. It was fully inverted in 2019 and 2006, and almost perfectly flat in 2000, according to Barron's.
"Nearly every recession we've had since the mid-1970s has been preceded by a period of time when the yield curve was inverted," said Wyett. "But that does not mean that the recession started at that point. While an inverted yield curve is a fairly accurate predictor that a slowdown in the economy is coming; it's a pretty poor predictor of when it's going to occur."
When it comes to economics, everything is connected, Wyett said.
"All of the economic headlines we've seen are at play here," he said. "From supply chain, to energy prices, to the Russia/Ukraine situation, to financial stimulus from the government."
Inflation is a big piece of the puzzle.
"Inflation has gotten way higher than what they anticipated it would, and it's lasting longer than the Fed and economists thought it would," he said.
The actions of the Federal Reserve have changed dramatically since the start of the year, Wyett said. Economists predicted two interest rate hikes to try to curb inflation but now expect eight or nine. That matters because the Fed's monetary policy has the largest impact on the short-term portion of the yield curve.
"This is a clear message from the bond market to the Fed that you need to be careful how quickly you raise interest rates," Wyett said. "Because the risk is, you're not just going to slow down the economy to bring down inflation a little bit, you might slow down the economy enough that you trigger a recession."
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