The yield curve has been a popular topic of discussion in the media in recent months. During the first week of December, many headlines declared that the yield curve had inverted. Inverted yield curves have generally been reliable indicators of past recessions, so this “inversion” gained a lot of attention. Does this mean we are headed for a recession? The short answer is that the media is focused on the wrong part of the curve and although the yield curve is flattening, we have not seen a true inversion yet. In normal economic periods, the yield curve slopes upward as longer bonds yield more than shorter bonds. Currently, short-term rates, which are controlled by the Federal Reserve, are rising faster than longer-term rates, creating a flat yield curve.

In early December, the yield on the 2-year Treasury was about 0.02% higher than the yield on the 5-year Treasury. The media highlighted this relationship as an inversion, but not only was the differential very small, it was likely a short-term trading aberration. The 2-year and 5-year also “inverted” in 1998, but this inversion was not followed by a recession. Generally, the relationship between the 2- and 10-year yields is a better indicator of a recession. At a spread of 0.18 percentage points, the 2-year and 10-year are close, but still in positive slope.

Historically, the probability of a recession doesn’t increase until the yield curve becomes substantially more inverted than a few basis points. The case for focusing on yield curves in the U.S. is based on the fact that they have made few false recession signals and many correct warnings. Still, it is unclear why the curve should matter, or which gap matters most.

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