"For sophisticated bond market investors, no three words invoke more fear and debate than 'inverted yield curve,'" writes CNBC contributor Mitch Goldberg. The reason: Inversions are seen as bad omens because they can forecast slower economic growth and precede recessions.
Every U.S. recession for the past 60 years followed an inverted yield curve, though sometimes not until months or even years later.
The government issues Treasury bonds over different lengths of time. Typically, a long-term loan pays more interest, so a 10-year Treasury bond will pay higher interest than a two-year one. The difference between the interest rates is known as the "spread." When the 10-year is higher, the spread slopes up. But when interest rates on a two-year are higher than a 10-year, the spread slopes down, meaning the curve is inverted.
Banks make profit by borrowing short-term at low interest rates and loaning money long-term at high interest rates. When the spread goes negative, banks have less incentive to issue loans, because doing so will cost them money. This means businesses can't access loans they need, and that can have negative repercussions for the economy.
At this point, the two-year has not passed the 10-year but, on Monday, the three-year passed the five-year, which hasn't happened since 2011. A lot of investors are taking that as a bad sign, especially since, as Reuters reports, "economists and investors are mindful that a downturn is inevitable."