The Irony Of The Inverted U.S. Yield Curve – May 30, 2023

A just-published report updated our investment strategy in view of ongoing global economic resilience and the recent upward tilt to DM government bond yields. In particular, we examined the bearish economic signal from the inverted U.S. yield curve in the past year.

Treasury bulls have cited the inversion of the U.S. yield curve as evidence that monetary policy is too restrictive, heralding a recession. The irony is that their economic pessimism and desire to hold government bonds (along with some unique distortions of the yield curve this cycle) have suppressed the cost of capital, which has worked to reduce the odds of a recession.

Our research highlighted that the yield curve has not always provided accurate signals. Moreover, the yield curve can often be a very early warning of recession, making it occasionally unhelpful in terms of investment strategy.

The “premature” inversion of the U.S. Treasury yield curve this cycle was partially been driven by bond investors (and the Fed) still embracing the secular stagnation narrative from last decade. The Fed believes that the longer-term “neutral” policy rate is only 2.5%, which it dramatically lowered last decade. Prior to that period, the rate was estimated to be 4% and our research indicates that it may be as much as 200 bps higher than the Fed currently forecasts. Keep in mind, the initial inversion of the yield curve was in July 2022, when the 10-year bond yield was just over 3% and policy rates were a mere 1.75%!

Net: this indicator has already failed in its role in heralding a recession, and we remain underweight government bonds in a multi-asset portfolio with a short duration bias.


  • All Research Highlights