Just after 6 a.m. ET on Wednesday, a rarely seen stock market phenomenon took place.
The yield (or amount of money you can make) on the 10-year U.S. Treasury bond dropped below the yield on a two-year treasury bond.
That may not seem catastrophic, but to market watchers, it is often a signal of storm clouds on the horizon for the economy.
The phenomenon is called a yield curve inversion, and what has worried some is that it has happened prior to the past seven recessions the U.S. economy has seen.
What does this mean to you and your wallet? Here’s a look at inverted yield curves.
What is a yield curve?
A yield curve is a line that plots the interest rates of similar bonds that have different maturity dates – or the date you can cash in the bond to get your money.
The yield curve that inverted on Wednesday tracked two-year bonds and 10-year bonds.
What is a bond?
A bond represents a loan from you to the issuer of the bond -- usually the government or a company.
Bonds, unlike stocks, do not give you a “piece” of the company. You have no ownership rights with a bond. You are simply loaning your money to an entity.
Why is yield curve important?
A yield curve is important because it is used as a benchmark for other loans – such as mortgages. When the yield curve inverts, it means that investors expect sluggish economic growth in the near future along with lower inflation.
For consumers, it usually means lower interest rates.
What happens when the yield curve inverts?
An inverted yield curve means that short-term bonds are paying more than long-term bonds. That means the money you loaned to the government or a company for a longer period of time will pay you a smaller return than will money you lent for a short period of time.
What does that say about the economy?
It goes to investor confidence. If investors think the economy is going to weaken and fear a recession, they'll settle for lower yields on their long-term debt.
Does an inverted yield curve indicate recession?
Yield curve inversions have, historically, preceded many U.S. recessions. Many economists believe that a yield curve inversion in 2005, 2006 and 2007 foretold the recession that crippled the world’s economy in 2008.
When was last yield curve inversion?
Prior to Wednesday, there was an inversion in late 2018.
Does inversion mean recession will happen soon?
Not necessarily. Other factors can change the inversion back to a more positive line.
However, if it should lead to a recession, a study by Credit Suisse showed a recession follows inverted yield curves by an average of about 22 months. Stocks continue to do well for about 18 months, the study showed.
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