Inverted Yield Curve
An inverted yield curve is one where short-term interest rates are higher than long-term rates on bonds of the same issuer. In the United States it has been one of the more reliable warnings of recession, though not an infallible one.
Also called: yield curve inversion · negative yield spread · inverted curve
Lenders normally want more for lending longer. Inversion happens when markets expect the central bank to cut rates in future, usually because they expect the economy to weaken, so long yields fall below short yields held up by tight current policy. It is usually measured as a spread on the yield curve: the Cleveland Fed and New York Fed both use the 10-year Treasury yield minus the 3-month bill yield.
The Cleveland Fed counts an inversion before each of the last eight US recessions; the inversion of May 2019 came almost a year before the recession that began in March 2020. It also lists false signals, including an inversion that ran from late 2022 to late 2024. The New York Fed turns the same spread into an estimated probability of recession twelve months ahead. The lag between inversion and downturn has varied widely.
Inversion hits lenders directly. Institutions that fund short and lend long see their net interest margin squeezed. Holders of Treasury bills and money market funds earn more than holders of longer bonds, which favours firms that keep customer reserves in short paper. A term premium that is unusually low can also flatten or invert the curve for reasons that have little to do with the growth outlook.
In practice
An inversion is a signal about expectations, not a cause of recession. Central bank bond buying and a compressed term premium can distort the signal.
Example
If the 3-month bill yields 5.3 percent and the 10-year note 4.0 percent, the 10-year minus 3-month spread is minus 130 basis points: a deeply inverted curve.
Learn more on Money Wiki
This page gives the short answer. Money Wiki has a longer guide to Inverted Yield Curve, with more detail and background.
Read “Inverted Yield Curve” on Money Wiki (opens in a new tab)
Commonly confused with
| Term | How it differs |
|---|---|
| Flat yield curve | A flat curve has similar yields across maturities. An inverted curve has short yields above long ones. |
See also
- Yield CurveThe yield curve plots the interest rates on bonds of the same credit quality across different maturities, usually government bonds from one month to thirty years. Its shape shows what markets expect for interest rates, inflation and growth.
- Term PremiumThe term premium is the extra yield investors demand for holding a long-term bond rather than rolling over a series of short-term ones for the same period. It cannot be observed directly and has to be estimated with models.
- Federal Funds RateThe federal funds rate is the interest rate at which US depository institutions lend reserve balances to each other overnight. The Federal Open Market Committee sets a target range for it, and that range anchors short-term dollar interest rates worldwide.
- Net Interest MarginNet interest margin is a bank's interest income minus its interest expense, expressed as a percentage of its interest-earning assets. It measures how much a lender earns on the gap between what it charges borrowers and what it pays for funds.
- Treasury BillA Treasury bill is a short-term government debt security, usually maturing within a year, that pays no coupon. It is sold below its face value and repaid at face value, and the difference is the investor's return.