Bond Market Commentary

Does an Inverted Curve Signal a Recession?

By Drew O’Neil
December 10, 2018

There has been a lot of talk about rising interest rates, the flattening of the yield curve, the potential for an inverted curve and the possibility that a recession could ensue. Are these relevant observations and how does all of this impact fixed income strategy?

The following graph depicts the 2- to 10-year Treasury spread (blue line) versus Fed Funds rate (red line) from 1986 through the last U.S. recession. When the blue line falls below the horizontal axis, the yield curve is inverted (shorter maturities yield more than longer maturities). This timeframe includes 4 periods of major Fed rate hikes, 3 periods of lengthy Fed rate cuts, 3 recessions and 3 inverted yield curves:

Remembering that past history is not necessarily an indicator of the future, there are several interesting observations:

Let’s isolate the last 10 years:

This relaxed pace has influenced mainly short-term rates. This is an important point, noting that recent flattening of the yield curve was driven mostly by rising short term rates. The recent 10 year Treasury trend has mirrored the long term general interest rate trend. There is no correlation to the noticeably more irregular slope or spread between the 2- and 10-year. (see the graph on the next page)

A common thought when the curve flattens is to shorten investment maturities. For example, on July 3, 2000, the 10-year Treasury was 5.99%. The 2-year was 6.29%. Pick-up yield AND shorten up! Two years later (July 3, 2002) when the 2-year Treasury matured, investors faced a much different rate environment with reinvestment choices on the 2- and 10-year at 2.79% and 4.76% respectively (note investment decision consequences in box). Clearly hindsight divulges why an inverted curve does not necessarily dictate that staying short is the answer. When planning fixed income strategy/allocation, the impulse to predict future rates needs to acquiesce to long-term planning. Even with interest rates much lower across the board, geopolitical uncertainty, lack of inflation and interest rate disparity may be formidable barriers to higher domestic rates.

2000 Investment/ Reinvestment Choices & Resulting Yield

10 years @ 5.99%
2 years @ 6.29%
2 years @ 2.79%
2 years @ 2.52%
2 years @ 5.17%
2 years @ 2.53%
(Weighted avg = 3.86%)
2 years @ 6.29%
8 years @ 3.98%
(Weighted avg = 4.42%)

Many investors utilize fixed income securities as the foundation of their portfolio. Rationale may be quite different versus that for growth asset investing. In order to strategically combat the man-made and natural market forces, it may take the discipline of long term planning.

To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of, FINRA’s “Smart Bond Investing” section of, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of

The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.

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