Keep Calm and Stop Worrying About 'Bondmaggedon'

The flattening of the yield curve is unnerving some investors because of its history of presaging recessions. But a narrow curve is hardly an efficient or timely signal, especially when it hasn’t yet inverted. Many factors account for the flattening of the curve, which could even offset the headwinds introduced by Federal Reserve interest-rate hikes by providing cheap, long-term financing. Economic expansion is likely to continue somewhat faster than desired by the Fed, and both short- and long-term interest rates could rise for the foreseeable future.

A flattening or inversion of the Treasury yield curve has almost always occurred prior to a recession. But the advance warning it provides has varied sufficiently that an inversion can only be considered a weak signal, at best, of an impending economic decline, as suggested by the table below. For example, the two- to 10-year yield spread flattened from more than 250 basis points to a mere 22 basis points in 1994 with no recession before widening out. In June 1998, it inverted to negative two basis points without a recession. It inverted again in February 2000 to minus 9 basis points, and the recession didn’t arrive until 13 months later. Similarly, the curve inverted to negative 10 basis points in February 2006, but the recession didn’t arrive for another 22 months. Apparently, even inversions do not necessarily or quickly lead to recession.