Economists Frederic Mishkin, who a decade later would serve on the central bank's Board of Governors, and Arturo Estrella said comparing yields "can have a useful role in macroeconomic prediction, particularly with longer lead times." The yield curve, they found, "strongly outperforms other variables at longer horizons" which "makes its use as a forecasting tool even more compelling."
In the more immediate case, the market is concerned that the 2-year note yielded higher than its 5-year counterpart during Tuesday trading. The general interpretation is that an inverted curve means investors are worried about longer-term growth and expect yields to be lower further out on the curve. Inverted curves have been reliable recession indicators for the past 50 years.
The difference between the 10-year and the 3-month notes, though, still remains significant.
That gap was around 49 basis points, or less than half a percentage point — definitely not an inversion, but at its lowest point in more than 11 years.
Gauging the spread between the 10-year and 3-month notes
"An inverted yield curve is often associated with the anticipation of a recession which may be why investors are nervous about it but I'm not convinced this is what's going on," Craig Erlam, senior market analyst at forex brokerage OANDA, said in a note.
"The Fed has been tightening policy at a decent rate and if the economy starts to slow then it makes sense that it may cut rates a little to provide some support. This would imply lower levels of growth which naturally is a drag on stocks and may therefore explain some of the selling today," Erlam added.
Indeed, the Fed is at the center of the rate fears. The central bank has been steadily hiking its short-term rate while longer-term rates have progressed less rapidly.
Fed officials largely have said they are watching the yield curve but view it as only one indicator among several they are monitoring regarding economic health. They, too, generally agree that the most relevant relationship is the 3-month/10-year comparison.