If you follow financial news, you’ve probably heard a lot of chatter lately about the flattening U.S. Treasury yield curve. But what is the yield curve and why does it matter?
The yield curve is a graph that shows the interest rates of bonds of equal credit ratings but various maturity dates. It’s an important tool for investors, as it can help predict impending economic events.
Under normal circumstances – when investors are feeling good about the economy – the yield curve slopes in an upward line from the left side (short-term maturities with lower yields) to the right side (long-term maturities with higher yields) of the graph.
Lately, however, the yield curve resembles more of a flat line. In fact, it’s the flattest it’s been in over a decade. And it’s been inching ever closer to inverting, at which point the line will form a downward slope and short-term yields will exceed long-term yields.
Economists and investors alike have been closely following the yield curve’s slope in recent weeks because yield curve inversions are considered reliable predictors of impending recessions – according to the San Francisco Federal Reserve, inversions preceded every U.S. recession for the past 40 years. At the same time, the San Francisco Fed also cautions that the yield curve remains a “comfortable” distance from inverting.
It’s also important to note that despite their predictive accuracy, yield-curve inversions have not led to immediate recessions. Over the last 40 years, the time elapsed between each inversion and its ensuing recession has ranged from six months to two years.
Since no one knows how long a recession will begin after the yield curve inverts, a reactive or knee-jerk investment decision could lead to missed gains or even losses.
Instead of panicking, take the time to review your portfolio to make sure it’s diversified across different asset classes, countries, and sectors – and that it aligns with both your long-term objectives and your risk tolerance.