Much has been made recently about inverted interest rates – when a shorter-term interest rate (typically the 3-month T-Bill yield) exceeds a longer-term interest rate (typically the 10-year Treasury Bond). This is the opposite of the usual relationship, in which longer-term yields are higher simply to compensate for the increased risks embedded in a longer holding period. But why is a rate inversion bad news?
The answer can be seen in the graphic below, from Mauldin Economics, which shows that yield inversions have preceded each recession (the gray areas of the chart) for the past 35 years. The San Francisco Fed reports inverted interest rates have preceded each recession of the last 60 years. So, a big deal indeed!