Yield curve inversion: definition

An upside-down curve

Normally, a ten-year loan pays more than a two-year loan: the lender asks for compensation for tying up money longer. The yield curve therefore rises with maturity. It is called inverted when short-term rates move above long-term rates.

The most followed measure is the gap between the US ten-year and two-year yields. The New York Fed prefers the ten-year versus three-month spread.

Why it worries

An inversion signals that the market expects rate cuts: short-term rates are pushed up by a restrictive central bank, long-term rates anticipate that it will have to ease because the economy will slow. In the United States, every recession since the late 1960s has been preceded by an inversion, with a very variable lag, often one to two years.

Its limits

The longest inversion in modern history, from mid-2022 to 2024, was not followed by a recession within the usual interval. Central bank bond purchases may have crushed long-term rates and blurred the signal.

For a trader, the moment the curve “un-inverts”, often because short-term rates fall when the central bank starts cutting, is sometimes more telling than the inversion itself.

Frequently asked questions

Does a curve inversion always signal a recession?

No. It is a historically reliable signal in the United States, but with an unpredictable lag and at least one recent exception.

What does steepening mean?

A widening gap between long and short rates, the opposite of flattening. After an inversion, the curve steepens as it returns to normal.