Yield Curve Inversions Explained

The Treasury yield curve is one of the most studied recession indicators in finance. Sustained inversions—especially of the 10-year minus 3-month spread—have preceded U.S. recessions in the post-war period, but lead times vary and the signal is not a precise timing tool. The 10-year minus 2-year spread is a popular proxy.

This article explains what the yield curve is, why inversions matter, and how to interpret them.

What is the Yield Curve?

The yield curve is a graph showing interest rates (yields) across different maturities for similar-quality bonds, usually U.S. Treasuries.

Normal Shape

Typically, the yield curve slopes upward:

Yield
  |                    *
  |                *
  |            *
  |        *
  |    *
  +---------------------------
     3M  2Y  5Y  10Y  30Y
          Maturity

Why upward? Investors demand higher compensation for locking money up longer (term premium) and for expected future rate increases.

Flat

Yield
  |    *    *    *    *    *
  |
  +---------------------------
     3M  2Y  5Y  10Y  30Y

What it signals: Uncertainty about the economic outlook; often a transition phase.

Inverted

Yield
  |    *
  |        *
  |            *
  |                *
  |                    *
  +---------------------------
     3M  2Y  5Y  10Y  30Y

What it signals: Markets expect future rate cuts—typically because they anticipate economic weakness or recession.

---

The 10Y-2Y Spread

The most-watched measure is the spread between the 10-year and 2-year Treasury yields:

10Y-2Y Spread = 10-Year Yield - 2-Year Yield

FRED series: T10Y2Y (10-Year Treasury Constant Maturity Minus 2-Year)

---

Why Inversions Matter

The Theory

An inverted curve suggests:

1. Markets expect rate cuts — The Fed only cuts when the economy is struggling
2. Short-term rates exceed long-term — Current policy is tight relative to expected future policy
3. Credit conditions tighten — Banks borrow short and lend long; flat/inverted curves reduce lending incentives

The Track Record

Yield curve inversions have a strong historical association with recessions, but:

• Lags are long and variable (often many months)
• Definitions matter (which spread, how “sustained”, and whether you use the level or a moving average)
• The signal is probabilistic, not deterministic

For a widely cited approach, the New York Fed publishes a recession probability model based on the 10-year minus 3-month spread.

---

The Lead Time Problem

Inversions are reliable but imprecise. Key points:

1. Long and Variable Lags

Inversions have preceded recessions by 6-24 months. You can't time the market based on inversion alone.

2. The "Un-Inversion" Signal

Some analysts argue the steepening after inversion (curve un-inverting) is more predictive of imminent recession than the initial inversion itself.

Why? The curve steepens when the Fed starts cutting—which only happens when trouble is already arriving.

3. This Time Is Different?

Arguments that "this time is different" have been made before every recession. However, structural factors (Fed quantitative easing, global yield compression) may affect interpretation.

---

Other Yield Curve Measures

10Y-3M Spread

Some prefer the 10-year minus 3-month spread:

Both have similar track records.

Near-Term Forward Spread

The Fed watches the spread between 3-month yields today vs. 3-month yields expected 18 months from now. This captures rate cut expectations more precisely.

---

Current Interpretation

As a Regime Input

VantMacro tracks the yield curve as a supporting recession-risk / financial-conditions signal (alongside CFNAI, credit spreads, and volatility). The current composite regime engine is driven primarily by growth, inflation, liquidity/policy, and market-risk inputs.

Combine with Other Signals

The yield curve is more powerful when combined with:

---

Common Misconceptions

"Inversion = Immediate Recession"

Reality: Lead times range from 6-24 months. Markets can rally significantly after inversion.

"A Flat Curve Is Fine"

Reality: A flat curve isn't "fine"—it's often a transition to inversion. Watch the trajectory.

"The Fed Controls the Yield Curve"

Reality: The Fed controls short rates; the market sets long rates based on growth/inflation expectations. The Fed can influence but not dictate the curve shape.

"Quantitative Easing Broke the Yield Curve Signal"

Reality: Possible, but the 2019 inversion still preceded the 2020 recession. The signal may be noisier but not broken.

---

How to Track the Yield Curve

DIY with FRED

1. Download DGS10 (10-Year Treasury) and DGS2 (2-Year Treasury)
2. Calculate: Spread = DGS10 - DGS2
3. Or use pre-calculated: T10Y2Y

VantMacro Dashboard

VantMacro displays:

• Current 10Y-2Y spread with historical chart
• Inversion alerts
• Integration with regime classification

View Economic Indicators →

---

Practical Takeaways

1. Inversions are warnings, not timing signals — They tell you risk is elevated, not when to act
2. Watch the trajectory — Flattening toward inversion is itself a signal
3. The un-inversion matters — When the curve steepens again, recession may be imminent
4. Combine with other signals — Yield curve + credit spreads + Chicago Fed National Activity Index = stronger signal
5. Don't dismiss "this time is different" — But be skeptical; the track record is strong

---

Summary

---

Data Sources

• FRED series: 10Y-2Y spread (T10Y2Y) — https://fred.stlouisfed.org/series/T10Y2Y
• FRED series: 10Y Treasury (DGS10) — https://fred.stlouisfed.org/series/DGS10
• FRED series: 2Y Treasury (DGS2) — https://fred.stlouisfed.org/series/DGS2
• FRED series: 10Y-3M spread (T10Y3M) — https://fred.stlouisfed.org/series/T10Y3M
• New York Fed: Yield curve and recession probabilities — https://www.newyorkfed.org/research/capital_markets/ycfaq

Methodology

• Tracks inversions via Treasury yield spreads (commonly T10Y2Y and T10Y3M) and interprets them as a macro risk indicator.
• Uses the shape (level and persistence) of the spread rather than single-day prints; brief inversions are less informative than sustained ones.
• Treats NY Fed recession probability models as complementary context (model-based, not ground truth).

Limitations

• Lead times from inversion to recession are highly variable (often 6–24 months) and can be disrupted by policy interventions.
• Term premium and structural factors (quantitative easing/tightening, global demand for Treasuries) can distort the curve relative to past cycles.
• The signal is about recession risk, not equity market timing; markets can rally for long periods after an inversion.

Further Reading

• Understanding Business Cycles — How the curve fits into cycle analysis
• Market Regimes Explained — Full regime framework

---

Track the Yield Curve on VantMacro

• Real-time 10Y-2Y spread with historical context
• Inversion alerts
• Integration with recession probability models

Explore Indicators Dashboard →