2-year Treasury Yields have been greater than 10-year yields going back to July of last year. Last month saw the sharpest decrease in this inversion since it began, but that trend seems to be reversing in April. Let’s break it down below:
Put simply, a yield inversion takes place whenever long-term interest rates drop below short-term ones. To the uninitiated, this may seem like no big deal, but history tells us otherwise.
Yield inversions are no-joke
And that’s putting it lightly… inverted yield curves are one of the most historically reliable indicators of an upcoming recession. Rather than sounding the alarm bells, we’re going to break down why this type of warning makes intuitive sense.
When you purchase a treasury bond you’re essentially loaning money to the US government, and the yield on that bond is the interest the government pays you in exchange for that loan.
Typically, you’d expect to receive more compensation- i.e. a higher yield- for a longer term loan. In a growing economy you want your money available for investment, not locked up in a 10 year bond. To compensate for missing out on those opportunities, you should receive a greater return on the loan. That’s if the economy is expected to grow…
If the economy is expected to decline, the opposite is true. Short term investments become riskier and investors prefer the security of long term bonds. As the demand for long term bonds increases, their returns drop and the yield curve inverts.
Which is exactly what happened last July.
So why should you care?
Well, economic growth and decline impacts everybody’s personal finance. We’re not telling you to sell all your stocks and short the US economy- although that would make for a sweet movie possibly starring Steve Carrel, Christian Bale, and Ryan Gosling (just off the top of our heads)- but here’s some smaller things you can do if you prefer an actionable hedge.
- Purchase short term treasury bonds. Higher yields on short term bonds and lower yields on long term ones are two sides of the same coin. If we are indeed headed towards a recession short term yields should jump. Lock them in now and you’ll have a valuable asset on your hands if everything else depreciates.
- Increase your contribution to an emergency savings account. There’s no safer way to protect your finances than upping the size of that account.