Inversion of the US yield curve and recessions: a leading signal, usually


The US 2-10s yield curve has been inverted since mid-2022, with no clear signs of an impending recession in the US economy. Thanks to the current risk-on mood, this looks like a “false positive”, as it did in the mid-1990s.


The inversion of the yield curve is known to be a leading indicator of US recessions.

Over the period shown on the graph, from 1984 to the present, the curve inverted three times (not counting the current episode) and was followed by a recession three times: in the late eighties, the late nineties and 2007. The significant flattening of the yield curve in 2019 will be set aside, as the Covid-19 pandemic passed through and caused a massive recession shock in 2020, unrelated to rate changes. Recessions are plotted by shaded areas and illustrated by an increase in the unemployment rate. As can be seen, the yield-curve inversion precedes the recession and the rise in the unemployment rate by several months.

But the recessive signal of the yield-curve inversion can also be offset by a favorable evolution of risk appetite and of other components of monetary and financial conditions, including equity markets.

The false signal of the mid-nineties is the best-known: the yield curve then flattened sharply and nearly inverted, reflecting the Fed’s surprise tightening in 1994. But there was no recession at that time. On the contrary, a fairly long period of growth followed and forged the concept of soft landing. The recession came later, in 2001, with the bursting of the Internet bubble.

Are we now facing a similar ‘false positive’? The future will tell. Meanwhile, the yield-curve has been sharply inverted since July 2022, just over a year and a half ago, reflecting a stronger rise in short-term rates than long-term ones, in the wake of the Fed’s massive monetary tightening. Yet, the US economy is still showing no clear signs of an impending recession. The rise in the unemployment rate remains very limited. While there are headwinds to growth the tailwinds are, to date, more important. The conditions for a soft landing seem to be in place. That would be a remarkable achievement.