Inverted Yield Curve: What you need to Know

You may be hearing a lot of talk about an inverted yield curve and how it likely predicts a recession.
We have had many questions on this topic and want to help guide our clients through this time of
market volatility and economic uncertainty with some basic facts.

So, what is the yield curve? What does it have to do with predicting a recession? Most importantly,
what does that mean for your financial planning?

A yield curve is simply a graphic representation of interest rates over a period of time. Since
investors typically require greater rates of interest to lend money for longer periods of time, the yield
curve normally slopes upward, meaning that short-term interest rates are lower than long-term
interest rates. Sometimes though, short-term interest rates can be higher than longer-term rates.
When this happens, the yield curve is said to be inverted.

Inverted yield curves are surprisingly good at predicting recessions. They are so good, in fact, that
they have predicted 10 out of the last 7 recessions. Yes, you read that correctly. In other words, yield
curves have been known to give false signals and predict recessions that never happen, especially
during unusual economic periods, such as the one we are in today. The unprecedented economic
stimulus during the Covid 19 pandemic created an environment of strong growth and rapid price
increases, and the Federal Reserve has been forced to raise short-term interest rates past the point
that it feels the economy can sustain in order to slow down the economy and stop the inflationary
spiral which has formed. So, in this case, the Fed is intentionally creating an inverted yield curve to
force an economic slowdown that could actually provide longer-term price stability.

Even when the yield curve has correctly predicted recessions in the past, it has not predicted the
timing or severity. Additionally, given that financial markets are normally leading indicators of change
in the economy, by the time a recession materializes, markets will have likely already priced it in.
Given this context, tactically, if you are still saving for retirement, this is a good time to limit longerterm
borrowing and use any excess cash to pay off high-interest debt. If you are already retired, you
can lock in higher interest rates and reduce your portfolio’s risk level with certificates of deposit and
high-quality bonds and bond funds. Strategically, as is almost always the case, it is wise to look past
the latest news stories and focus on your long-term goals using the personalized investment plan
that we have designed for you.

Kansas City Business Journal’s

“20 to Know in Financial Services”