Consider the inverted yield curve as the equivalent of an economic bogeyman. It's when the natural order up-ends and short-term interest rates are higher than long-term ones.
The Treasury bond yield curve inverted December 27 for the first time in five years. That gave shudders to those who see the phenomenon as a harbinger of recession. And yet, the U.S. economy is strong, and surveys show most forecasters think it will stay that way. So what does the inverted yield curve really mean?
"I think it sometimes portends a recession, sometimes not," says Marshall E. Blume, finance and management professor at Wharton. This time, it probably does not, he adds. "All the forecasts are quite favorable. There aren't any real excesses in the economy at the current time, and you usually think of recession as a tonic to the economy, to undo excess."
Business inventories are not excessively high, Blume notes. Recent government data has shown inflation picking up, which can lead to recession. But most of that is due to the oil-price jump last year, and oil has leveled off and doesn't appear likely to rise further. Also, the economy is less dependent on oil than it was during the recession-bound '70s, so oil-price increases are less likely to infect the broader economy, Blume says.
In fact, it's a bit of a stretch to describe today's yield curve as inverted, suggests Wharton finance professor Robert F. Stambaugh. "I certainly wouldn't describe it as a sharply inverted yield curve. It's 'flatish' and downward-sloping in some segments."
The yield curve is a graph with a line tracing short-term yields on the left and longer term yields as it moves to the right. Typically, rates for one- and three-month Treasury bills on the left are several percentage points lower than those of 10-, 20- and 30-year Treasury bonds on the right, as investors demand higher yields for tying their money up longer.
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