The inverted yield curve is hailed as a US recession indicator. When the curve between the US10y and the US02y inverts many investors take that as a sign that a recession is heading towards the US. In the last 50 years, every time the yield curve has inverted it has signalled a recession apart from once. So, this is what it is and how to recognise it.
What is the inverted yield curve?
It is simply when the short end of the yield curve is moving higher more quickly than longer-dated bonds. The reasons for this is the fact that shorter-dated bonds tend to be more sensitive to immediate interest rate expectations. The longer end of the curve is more sensitive to medium-term growth and inflation expectations.
So, why is the yield curve moving towards inversion now?
It is simply because US 2 year yields are surging higher on expectations that the Fed will have to aggressively hike rates to contain surging inflation. However, the longer dates US 10 year yields are looking at being capped at around 2%. The medium-term expectation for inflation is that it will drop. So, the short end of the curve is moving higher more quickly than the longer end. It is moving towards inversion.
Now, an actual inversion of the curve is highlighted on the chart below. Each time the curve inverts you can see the feeling in stocks. This is because in these situations companies find it more costly to fund their operations.
Furthermore, consumer borrowing costs rise and consumer spending decreases. This is why companies often report lower profitability.
For a rationale on the place that US S&P500 dip buyers are expected to enter see here.