What is an inverted yield curve and why its normalization does not mean the end of risk

The Inverted Yield Curve: Still the Most Reliable Recession Indicator

Few economic indicators are held in such high regard—or fear—as the inverted yield curve. Since the 1960s, the spread between 10-year and 2-year U.S. Treasury bonds has predicted every U.S. recession with one single exception in the 1960s. This makes it 8 out of the last 9 recessions. Not bad for a simple interest rate spread.

What the Curve Measures and Why It Inverts

Under normal economic conditions, long-term interest rates are higher than short-term rates—investors want more yield to “lock up” their money for 10 years than for 2. However, when short-term interest rates rise above long-term rates, it usually signals that markets expect slower growth, rate cuts, and a potential recession.

This inversion happens when the Federal Reserve aggressively raises interest rates, pushing up the short end of the curve while long-term rates remain stable or even fall due to pessimistic economic expectations.

How Reliable Is This Indicator? Let’s Look at History

Here’s a review of U.S. recessions since 1968 and whether the 2-year/10-year yield curve inverted before them:

This shows 8 out of 8 major recessions were preceded by an inversion.

Only in 1966 was there a false signal—an inversion without a subsequent recession—but even then, economic growth slowed sharply.

Current Behavior of the Curve:

The chart below shows the recent behavior of the spread between the 10-year and 2-year yields. The curve inverted in mid-2022, reaching a low of -108 basis points in July 2023—an extremely rare level historically.

Since then, it has risen back to +53 basis points, but as we see in the right part of the chart:

• We are still 2.24 standard deviations above the average.
• In the 99.17th percentile for the given period.

This indicates that the curve has not yet returned to its normal level, and the likelihood of a mid-term reversion to the mean remains high.

Does a Normalizing Curve Mean the Danger Is Over?

Historically, recessions tend to follow inversions, not coincide with them. The curve often begins to normalize when:

• The Federal Reserve prepares to lower interest rates.
• Markets expect stimulus due to a slowdown.
• Investors anticipate a policy change.

So, the curve now straightening is not a sign that we’re out of danger—it’s more likely a sign that the warning may soon materialize.

Conclusion: Not Just an Inversion, but an Extreme One

The longer the curve is inverted, the stronger and more reliable the recession warning. This makes the current situation not just a signal, but a highly probable forecast for economic downturn—especially combined with other risk factors such as global growth slowdown and uncertain monetary policy.

Historical data shows that recessions usually occur between 6 and 18 months after the yield curve “straightens” (i.e., after the inversion ends and the spread between the 10-year and 2-year bonds turns positive again).

Examples from the Past:

With the spread at statistically extreme levels and almost perfect historical accuracy since the 1970s, it would be premature to dismiss the curve just because it has returned to positive territory.

The likelihood of a reversion to the mean remains high, and considering the heightened global trade uncertainty, we may see a sharp turnaround. In any case, the message from the bond market is clear: the cycle is not yet over.