What is the yield curve?
This is the line plotted on a graph that shows the rate of return on government bonds to their date of maturity.
Government bonds – known as gilts in the UK, treasuries in the US and bunds in Germany – are debt issued over a fixed period of time, typically three months, two years, 10 years and 30 years, to fund government spending.
The yield is the rate of return investors receive. Maturity is when the government repays the debt at the end of the term. When more investors are buying government bonds prices go up, and yields drop.
Companies can also issue bonds.
What happens when the yield curve inverts?
This is when the yield on short-term bonds is higher than on long-term bonds. It means that traders are accepting a lower interest rate to hold longer-dated bonds than the shorter-dated alternative.
It’s relatively rare – investors typically get higher returns for lending over the long term, as this is seen as riskier than short-term lending. They also expect to be compensated for the impact of inflation, which will eat into investments over time.
What does it mean?
An inverted yield curve is a classic signal of a looming recession – in the US, the curve has inverted ahead of every recession over the past 50 years. It falsely signalled a recession just once, at the time of the 1998 Russian financial crisis.
For other countries the signal is less clear. Several have experienced long periods of inverted yield curves without a subsequent recession, notably the UK in the 1990s.
Why is it happening now?
The yield curve for two- to 10-year US government bonds has inverted for the first time since 2007, just before the start of the global financial crisis. This indicates that investors are seriously worried about an economic downturn, which would keep inflation low. They are worried about the impact on the already-weak global economy of the prolonged trade war between the US and China, along with Brexit.
Is recession inevitable?
No, but it is highly likely. And an inverted yield curve driven by recession fears risks becoming a self-fulfilling prophecy, knocking confidence and causing businesses to cut back on investment.
How soon does recession tend to follow yield curve inversion?
Previous downturns show that yields have typically inverted 18 months, on average, before a recession began. Julia Kollewe