What’s a Yield Curve?

The hot topic is the yield curve or, more importantly, the inverted yield curve. A yield curve is a collection of interest rates, or yields, plotted on a chart, beginning with the One-Month US Treasury Bill and ending with the 30-Year US Treasury Bond, plotting all points in between to determine whether it is inverted.

Historically, the yield curve slopes upward and to the right because short-term rates have been lower than long-term rates. It makes sense. If you buy a 30-year bond, you want to earn more interest for your risk exposure.

The yield curve can be normal, flat, or inverted. A normal yield curve occurs when long-term rates yield more than short-term rates. If the yield curve is flat, it doesn’t matter which bond you buy because all rates are the same. When the yield curve inverts, you earn more interest from short-term bonds than from longer ones.

A normal yield curve signals a strong economy with no known issues on the horizon – ceiling and visibility unlimited. When the curve inverts, trouble awaits. What trouble? A recession. An inverted yield curve has previously been a reliable recession indicator, and it’s a sign the economy may be losing steam. The current yield curve is inverted. The US 2-Year Treasury Note yields 4.02% while the 10-Year yields 3.55%, and the spread between the two is the widest since 1980.

An inverted yield curve is a good recession indicator; however, the correlation between an inverted yield curve and a recession is not instantaneous. It may take one to two years before a recession occurs, if it happens at all, after the inversion because it takes time to slow down a $26 trillion economy.

The effective Fed Funds rate is 4.83%, the only rate the Federal Reserve controls. The remaining rates are left to market participants – buyers and sellers. Monitor the US 2-Year Treasury yield to determine where the Fed is heading. It currently yields 4.02%, down from 5.05% earlier this year.

In the movie Top Gun, Maverick and Goose inverted their F-14 Tomcat to take a picture of a Russian MIG pilot. After the encounter, they returned the plane to normal, flew back to Miramar, and buzzed the tower. Their inversion didn’t hinder their ability to fly their aircraft.

Slower growth doesn’t mean any growth. If our economy traveled 75 miles per hour a couple of years ago, it might be cruising at 55 MPH today.

Our economy is strong, corporate earnings are decent, interest rates are stabilizing, and taxes are favorable. These factors bode well for a higher stock market at some point. Follow your plan, diversify your assets, and think generationally; good things can happen.

Because I was inverted. ~ Maverick, Top Gun

March 30, 2023

Bill Parrott, CFP®, is the President and CEO of Parrott Wealth Management in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on your asset level.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor. Prices and yields are for today only and are subject to change without notice.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.