Many economists look to the bond market yield curve as an early sign of a major market correction. Market-watchers consider yield inversions as an early warning sign, a potential “canary-in-the-coal-mine. “Historically, the short- and long-term bond rates have an “inversion” approximately a year before a recession
An inverted yield curve occurs when short-term interest rates are higher than long-term interest rates. Essentially, investors expect a higher return on longer-term investments, as they are locking themselves into the investment and expect to get paid for that commitment. However, as markets go through cycles, these returns also reflect the market conditions and anticipations.
According to TheBalance.com, “when a yield curve inverts, it’s because investors have little confidence in the near-term economy. They demand more yield for a short-term investment than for a long-term one. They perceive the near-term as riskier than the distant future. They would prefer to buy long-term bonds and tie up their money for years even though they receive lower yields. They would only do this if they think the economy is getting worse in the near-term.”
Inversions can occur several times before the overall economy turns downward. In the Great Recession of 2007/8, there were three preceding inversions (2005, 2006, 2007). An inversion occurred in late 2018, so this is the second in this current up cycle.
According to Reuters: “The U.S. curve has inverted before each recession in the past 50 years. It offered a false signal just once in that time.”
Note that past performance is not a guarantee of future performance.