Experts say something called the yield curve is dangerously close to predicting another U.S. recession. But what does that mean?
Terms straight out of economics class don't often find their way into everyday conversation, so we'll try to break it down into plain English -- and let you know if there's anything you can do to protect yourself.
So, like, what is the yield curve?
Simply put, the yield curve is the difference in interest rates between long- and short-term government bonds. Think 10-year Treasury notes versus 2-year notes.
When things are going well for the economy, rates on long-term bonds are higher than rates on short-term bonds. In exchange for the risk of locking away your money for a longer period, you get higher interest.
It's protection against the inflation that can flare up during a stronger economy and hurt the value of your money.
What's the problem now?
But recently, long-term bond yields haven't been rising much — the rates have been looking kinda meh. That weakness suggests traders aren't confident about the economy's ability to grow.
At the same time, the Federal Reserve has gradually been raising short-term interest rates. So, the difference between long- and short-term rates has been flattening out.
"We do not believe that the flattening of the yield curve poses an immediate risk to the economy, as it aligns with our view that the economic recovery that began nine years ago is currently in the latter innings," says George Mateyo, chief investment officer at Key Private Bank.
The trouble comes if shorter-term investments start paying higher interest than longer-term ones. That's called an inverted yield curve — and historically, it has spelled recession.
Why should we trust it?
The shrinking gap between interest rates has some financial pros ready to turn on Wall Street's version of a tornado siren.
Here's why: The yield curve has accurately predicted every recession over the past 60 years. The sole exception was in the mid-1960s. But even then, the economy slowed down drastically, stopping just short of a recession.
Note that while an inverted yield curve can indicate a recession is coming, it's no help with telling us when that will happen.
Sometimes, a recession has come six months later. Other times, it has taken as long as two years.
What should you do?
The last thing you want to do is panic. Because if everyone starts worrying about a recession, that can be enough to send the economy right into the tank.
If investors become concerned enough about a downturn, they could start shoveling money into long-term government bonds as a safe haven.
The demand for bonds would send their prices rising and push long-term interest rates lower — making an inverted yield curve all the more likely, and pushing the economy even closer to a recession.
For now, Key Private Bank's Mateyo is advising investors lessen their exposure to Treasury bonds, and stay alert.
"Should the yield curve invert — an event marked by short-term rates exceeding long-term rates — greater caution would be warranted," he says.
So, don't do anything rash that could ultimately be stacking your own deck against you. Instead, keep spending as usual — to help keep the economy healthy.
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