What is the yield curve and why should I care? The yield curve is a graph of the yields that government bonds are paying, arranged in order of time to maturity. You should care because the cost of mortgages, bank loans, student loans, corporate bond yields, etc., are all set with reference to various government yields. Another reason you should care is that the yield curve can (seemingly) predict the future.¹ It has predicted all seven recessions since the late 1960s. Yes, you read that right. All seven. It did make one bad call back in the mid-60s, so it’s not infallible. If its record continues, there is a chance of a recession sometime either side of Election Day 2020. Take a deep breath. A recession is not guaranteed. It’s just a possibility we should consider, given the yield curve’s track record.
The curve’s predictive power shows itself through what is called an inversion. The curve is inverted when a short term yield is higher than a long term yield. The usual state of things is that longer term bonds yield more than shorter term bonds.
The Federal Reserve’s preferred measure for whether the yield curve is upward sloping or inverted is the relationship between three month bills and ten year notes (3m10y). That is the one I’m going to talk about. Many market commentators prefer the difference between the two year note and the ten year. It’s a free country. Continue reading