Current United States Treasury Yield Curve & how it can be used to predict recessions

Statistic: Treasury yield curve in the United States as of February 17, 2023 | Statista
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What is the Treasury Yield Curve?

The treasury yield curve is a graph that plots the yields, or interest rates, of U.S. Treasury bonds with different maturities. The yield curve is usually upward sloping, meaning that long-term Treasury bonds have higher yields than short-term Treasury bonds.

The yield curve is closely watched by investors, economists, and policymakers as an indicator of economic conditions and expectations. The Federal Reserve, for example, closely monitors the yield curve as part of its efforts to set monetary policy and manage the economy.

How to interpret the Yield Curve to help predict an upcoming recession

Diagram of the 4 yield curve shapes

The United States Treasury Yield Curve is quite useful in predicting upcoming recessions.  This can be done by assessing the the shape of the yield curve as it alters depending on the short & long term interest rates on bonds and thus can provide insights into the expectations and perceptions of investors about the economy.

The four main types of yield curves are:

Normal Yield Curve: This is the most common yield curve, where the long-term yields are higher than the short-term yields. The normal yield curve shows that investors have higher expectations for economic growth and inflation in the future. This is because long-term bonds are riskier than short-term bonds and investors require a higher yield to compensate them for holding the bond for a longer period.

Inverted Yield Curve: This occurs when short-term yields are higher than long-term yields. An inverted yield curve is often seen as a warning sign of an economic recession because it suggests that investors have lower expectations for economic growth and inflation in the future. Inverted yield curves often occur when the central bank raises interest rates to control inflation and slow down economic growth.

Flat Yield Curve: This occurs when there is little difference between short-term and long-term yields. A flat yield curve may suggest that investors are uncertain about the future direction of interest rates and inflation. It can also occur when the economy is in a transition period between economic expansion and contraction. A flat yield curve can be a signal of economic uncertainty, but it doesn’t necessarily indicate a recession.

Humped Yield Curve: This is a less common type of yield curve where medium-term yields are higher than both short-term and long-term yields. The humped yield curve can indicate that investors expect interest rates to rise in the short term, but they also expect a decline in interest rates in the long term. This type of curve can occur when market conditions are uncertain, and investors are expecting changes in monetary policy. The humped yield curve can be a signal of economic slowdown or contraction, but it’s not necessarily an indicator of a recession.

What is a Recession?

Imagine the economy as a high-stakes game, where fortunes are made and lost with every twist and turn. When the chips are down and we’re in the midst of a recession, it’s like we’ve all drawn the dreaded “Go Directly to Jail” card in Monopoly, and we’re left scrambling to find our “Get Out of Jail Free” ticket.

A recession is a period of negative economic growth that lasts for at least two consecutive quarters (six months). This is the equivalent of a six-month-long storm cloud hovering over the economy, casting a shadow on all our financial endeavors. In this gloomy scenario, businesses and consumers alike tighten their belts, causing a domino effect of reduced demand, stagnating growth, and a chorus of sighs as key indicators like GDP, employment, and investment spending take a nosedive.

So what are the puppet masters behind these economic downpours? Sometimes, it’s high interest rates or a sudden drop in consumer confidence that pull the strings. Other times, it’s the unpredictable curveballs life throws our way—natural disasters, geopolitical events, or a misstep in government policies—that send the economy into a tailspin.

As we navigate this high-stakes game, economists and policymakers are like our master strategists, eyes glued to the economic chessboard, ready to make their next move. With a blend of cunning tactics and calculated risk-taking, they aim to outmaneuver, mitigate, or recover from the recessions that threaten to dampen our financial spirits.

So, grab your umbrella and put on your game face, because navigating the unpredictable world of recessions is all part of playing the grand game of life.

Recessions & their relation to the Stock Market

Historically, it has been difficult to pinpoint the exact length of time it takes for the S&P 500 to find a bottom after a recession is declared. This is because market bottoms often do not align perfectly with the beginning or end of a recession. In some cases, the stock market may bottom before the recession officially starts, while in others, it might bottom after the recession has been underway for some time.

To give you a rough idea, let’s look at a few examples from past U.S. recessions:

1973-1975 Recession: The recession began in November 1973, and the stock market bottomed in October 1974, about 11 months after the start of the recession.
1980 Recession: The recession started in January 1980, and the stock market bottomed in March 1980, just 2 months later.
2001 Recession: The recession began in March 2001, and the stock market bottomed in October 2002, about 19 months after the start of the recession.
2007-2009 Great Recession: The recession started in December 2007, and the stock market bottomed in March 2009, about 15 months after the beginning of the recession.

As you can see, the time it takes for the S&P 500 to find a bottom varies widely, ranging from a couple of months to over a year. It’s important to note that these examples are not exhaustive and that each recession has its unique factors and conditions that can influence the stock market’s behavior.