Yield Curve Inversion

A yield curve inversion occurs when short-dated Treasury yields exceed long-dated ones, most commonly measured as the 2s10s spread turning negative. It is abnormal: investors usually demand extra yield to lend for longer, so an inverted curve means the market expects short rates to fall substantially, which historically has meant a Fed cutting into economic weakness.

The signal’s reputation is earned. An inverted 2s10s or 3-month/10-year curve has preceded every US recession for the past half century, typically with a lead of 6 to 24 months. Desks care about three distinct phases:

• Inverting: the market starts pricing a policy mistake or late-cycle overtightening.
• Depth: deeper inversion (e.g. −100bp) signals more aggressive expected cutting.
• Re-steepening: historically the recession tends to arrive after the curve un-inverts, as the Fed slashes the front end: the most dangerous-looking “good news” in macro.

Worked example: The 2-year sits at 4.80% and the 10-year at 4.10%: 2s10s is inverted at −70bp. Eight months later, weak payrolls push the Fed toward cuts; the 2-year collapses to 4.05% while the 10-year holds 4.15%. The curve un-inverts to +10bp: a bull steepening that history says warrants more caution, not less.