Reading the Yield Curve: What Inversions Have Predicted

The yield curve plots government bond yields across different maturities — from short-term treasury bills to 30-year bonds. Under normal conditions, it slopes upward: investors demand a higher yield to lock up their money for longer, to compensate for the extra risk and uncertainty. When that relationship flips — short-term yields rise above long-term yields — the curve is said to be "inverted," and this has historically been one of the more reliable signals that a recession may be approaching within the following one to two years.

Why inversion happens

An inversion typically occurs when a central bank raises short-term policy rates aggressively to fight inflation, while long-term yields rise more slowly because bond markets are pricing in an expectation that growth (and therefore future rate levels) will eventually slow. In effect, the long end of the curve is a market-implied forecast of the average short-term rate over the life of that longer bond — so a curve that inverts is the market saying it expects rates, and by extension the economy, to weaken from here.

What the track record actually shows

• Every US recession over the past several decades has been preceded by a yield curve inversion, which is why the signal is taken seriously.
• Not every inversion has been followed by a recession within a short window — there have been instances where the lag between inversion and recession stretched well beyond the typical 12-18 month window, and periods where a mild inversion did not precede a recession at all.
• The signal tends to fire well ahead of the actual downturn, and equity markets frequently continue rising for months after an inversion first appears — which is why using it as a precise market-timing tool has a mixed track record even when its longer-run predictive power as a recession indicator is real.

The more defensible way to use the yield curve is as one input among several in assessing recession risk — alongside labour market data, credit spreads, and leading economic indicators — rather than as a standalone trading signal with a precise, reliable lead time.