Quick takes on capital markets

11 Feb 2022

Treasury yield curve: Signaling r-r-r-recession?

An inverted yield curve is a recessionary signal. Yet, despite recent curve flattening as markets price in a steep Fed hiking cycle, strong consumer spending power, cash-rich balance sheets, and modestly tight credit spreads point to investor fears of a looming recession being overblown.

Yield curve steepness
10-year minus 2-year yields, recessions are shaded, 1975 – present

Stock market pullbacks chart
Source: Clearnomics, Federal Reserve, Principal Global Investors. Data as of February 9, 2022.

The U.S. Treasury yield curve has inverted ahead of every U.S. recession since the 1950s. In recent months, the curve has flattened, significantly, prompting some investors to whisper the "R" word.

The 2s10s Treasury yield curve (the difference between the yields on 2-year and 10-year U.S. government debt) has flattened from a peak of 158 basis points (bps) in late Q1 2021 to under 50bps today. In previous Federal Reserve (Fed) hiking cycles, the spread has narrowed by around 80bps in the first year of tightening. On that basis, the curve could invert within the year. However, there are three important considerations:

  1. The huge quantities of government bonds owned by central banks are suppressing long-term yields. Given the lower starting point, it may be easier for the curve to invert, thus fading the recessionary signal.
  2. Markets have already priced in significant Fed tightening for 2022, so some of the "first-year flattening" has likely already occurred.
  3. The lead time between curve inversion and recession tends to be long and variable, on average 12-18 months, but sometimes extending to four years.

Other factors paint a more reassuring picture. Consumers have a huge excess savings cushion, corporate balance sheets are cash-rich, and credit spreads—another recessionary signal—continue to be relatively tight. It's far too early to start uttering the "R" word.

Recalibrating Risk: Actionable insights to power portfolios


Wall Street Journal Custom Content is a unit of The Wall Street Journal advertising department. The Wall Street Journal news organization was not involved in the creation of this content.

Investing involves risk, including possible loss of principal. Past performance is no guarantee of future results and should not be relied upon to make an investment decision. The U.S. government does not guarantee the principal or coupon payments of non-U.S. Treasury bonds. Fixed-income investments are subject to interest rate risk; as interest rates rise their value will decline.

The information presented has been derived from sources believed to be accurate; however, we do not independently verify or guarantee its accuracy or validity. Any reference to a specific investment or security does not constitute a recommendation to buy, sell, or hold such investment or security, and does not take account of any investor's investment objectives or financial situation and should not be construed as specific investment advice, a recommendation, or be relied on in any way as a guarantee, promise, forecast or prediction of future events regarding an investment or the markets in general. The opinions and predictions expressed are subject to change without prior notice.

Principal Funds, Inc. is distributed by Principal Funds Distributor, Inc.

For Public Distribution in the United States. For Institutional, Professional, Qualified and/or Wholesale Investor Use Only in other Permitted Jurisdictions as defined by local laws and regulations.

Principal®, Principal Financial Group®, and Principal and the logomark design are registered trademarks of Principal Financial Services, Inc., a Principal Financial Group company, in the United States and are trademarks and services marks of Principal Financial Services, Inc., in various countries around the world.

Principal Global Investors leads global asset management at Principal.®