Many of the people who completely missed the worst recession since the Great Depression are trying to get out front and tell us about the next one on the way. The big item glowing in their crystal ball is an inversion of the yield curve. There has been an inversion of the yield curve before nearly every prior recession and we have never had an inversion of the yield curve without seeing a recession in the next two years.
Okay, if you have no idea what an inversion of the yield curve means, it probably means you’re a normal person with better things to do with your time. But for economists, and especially those who monitor financial markets closely, this can be a big deal.
An inverted yield curve refers to the relationship between shorter- and longer-term interest rates. Typically, the longer-term interest rate — say, the interest rate you would get on a 30-year bond — is higher than what you would get from lending short-term, like buying a three-month U.S. Treasury bill.
The logic is that if you are locking up your money for a longer period of time, you have to be compensated with a higher interest rate. Therefore, it is generally true that as you get to longer durations — say, a one year bond compared to three-month bond — the interest rate rises. This relationship between interest rates and the duration of the loan is what is known as the “yield curve.”
We get an inverted yield curve when this pattern of higher interest rates associated with longer-term lending does not hold, as is now the case. For example, on March 27, the interest rate on a three-month Treasury bill was 2.43 percent. The interest rate on a 10-year Treasury bond was just 2.38 percent, 0.05 percentage points lower. This means we have an inverted yield curve.
While this inversion has historically been associated with a recession in the not too distant future, this is not quite a…