Yields on U.S. treasuries are one of most closely watched market indicators. One key measure is the "yield curve," which shows the interest rates on Treasury bonds with different maturities. Most of the time, long-term bonds, like 10-year ones, offer higher returns than short-term bonds, like 2-year ones. This is called a "steep" yield curve. When this pattern flips, and short-term bonds offer higher returns than long-term ones, it’s known as an "inverted yield curve." Many experts see this as a warning sign of slower economic growth or even a potential recession.
Figure 1 plots the most common yield curve—the difference in yields between 10-year and 2-year Treasury bonds. When the difference is negative, it means the yield curve is inverted. This happened in July 2022, and the curve stayed inverted for over two years until just two weeks ago when it normalized again.
Figure 1: Yield Spread Between 10-Year and 2-Year Treasury Bonds
Yield curve inversion typically occurs during a tightening cycle of monetary policy when central banks raise interest rates to contain inflation and prevent overheating the economy. The recent normalization of the yield curve coincides with the anticipated start of interest rate cuts by the Federal Reserve, as soon as this week, as the Federal Reserve Open Market Committee deliberates on its benchmark interest rate during the meeting on Sept. 17-18.
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