Yield Curves And The Economy

At first blush, it may appear that an inverted yield curve is desirable. After all, this is a possible indication of expected lower inflation in the future. However, the the past six recessions in the U.S. dating back to the 1960s have been preceded by an inverted yield curve. Recent Fed actions have led to a change in the interpretation of yield curve as Fed actions have flattened the yield curve by taking risk out of the system, reducing the term premium, or extra return for taking the risk associated with longer term bonds. Instead, the term premium between other financial instruments such as high-yield bonds may be more indicative of future economic stability. As this article highlights, even though the term premium for Treasury bonds has flattened, the term premium for high-yield bonds (Actually credit default swaps on those bonds: Think of it as insurance that only pays out if those bonds default.) has increased.