For the first time since 2007, the 2- to 5-year US Treasury yield curve has inverted. Historically, this has served as a somewhat reliable indicator of economic downturn, which means people are freaking out, which means…
OK, hold up: What exactly is a yield curve, and why is it inverting?
‘Lend long and prosper’ (so say the banks)
In short, a yield curve is a way to gauge the difference between interest rates and the return investors will get from buying shorter- or longer-term debt. Most of the time, banks demand higher interest for longer periods of time (cuz who knows when they’re gonna see that money again?!).
A yield curve goes flat when the premium for longer-term bonds drops to zero. If the spread turns negative (meaning shorter-term yields are higher than longer maturity debt), the curve is inverted…
Which is what is happening now
So what caused this? It’s hard to say — but we prefer this explanation: Since December 2015, the Fed has implemented a series of 6 interest rate hikes and simultaneously cut its balance sheet by $50B a month.
According to Forbes, the Fed has played a major part in suppressing long-term interest rates while raising short-term interest rates.
Yield curve + inversion = economic downturn (sometimes)
The data don’t lie. A yield curve inversion preceded both the first tech bubble and the 2008 market crash.
Though, this theory has had some notable “false positives” in its lifetime — so it’s not exactly a foolproof fortune teller.
Heck, IBM found the size of high heels tends to spike during hard times. As of now, the experts who believe the sky to be falling remain in the minority.