Nobody cares about the inverted yield curve anymore.
It used to be a big deal. After all, an inverted yield curve – when short-term interest rates are higher than long-term rates – has an excellent track record for predicting recessions.
So folks who pay attention to it can avoid a lot of financial heartache.
But the current inversion has lasted for so long, it feels normal. People aren’t worried about it. No one cares anymore.
We should care, though – because the yield curve is quickly moving toward the point where trouble happens.
Take a look at this chart…
This chart shows the interest rate on the 10-year Treasury note minus the rate on the three-month Treasury note.
Most of the time, this chart shows a positive number. That makes sense since long-term interest rates are usually higher than short-term rates.
But the yield curve turned negative over two years ago.
When it happened, lots of folks worried that the U.S. economy was headed toward a recession. After all, every other time the yield curve flipped negative, the economy contracted shortly afterward.
But readers who look closely at the chart will notice that the trouble doesn’t happen when the yield curve turns negative. Instead, the problems occur when an inverted yield curve shifts back into positive territory.
That’s what happened in late 2000 and late 2007. It happened just before the COVID-induced recession in 2020. And it’s what’s likely to happen when the yield curve turns positive again – which could be a lot sooner than most folks expect.
The yield curve has been rising over the past month. It was -1.23 on September 15 – right before the Federal Reserve lowered its target for short-term interest rates. The yield curve is -0.61 today.
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In other words, the yield curve has recovered half of its inversion over the past month.
Part of that is due to the Fed lowering short-term rates by 50 basis points. Part of it is due to the rise in longer-term rates.
If we see similar action in the coming weeks, then the yield curve could be back in positive territory by Christmas, if not before.
In fact, the fed funds futures market is already pricing in a 100% chance of the Fed lowering short-term rates another 50 basis points over its next two meetings.
That’ll be just enough to push the yield curve back into positive territory. And if history is any sort of a guide, then the economy is headed toward turbulence in 2025.
Best regards and good trading,
Jeff Clark
Editor, Market Minute