The U.S Treasury yield curve is flattening after a long stretch of inversion. Since 2022, short-term interest rates have exceeded long-term interest rates, showing a downturn. This inversion has been present for nearly 2 years, surpassing the 623-day record, which was set in 1978. Remarkably, no recession has arrived yet. In May of 2025, the yield curve became inverted as long-term yields surpassed short-term yields. Investors are now questioning whether this is an all-clear signal or simply an indication of something yet to come.
Curve inversions are watched closely as recession predictors. There are two explanations for inversions. First, tightening reflects excessively tight monetary policy, which causes growth to slow and the Fed to lower rates. These cuts can hurt investors in short-maturity bonds as they are forced to invest at lower future rates. This pushes prices up and yields down on longer-term bonds. Second, a slowing economic environment indicates that other asset classes, such as equities, face headwinds. Therefore, investors ditch riskier assets for long-term bonds, decreasing long-term yields.
Historically, yield curve inversions have an almost unblemished record for foreshadowing U.S recessions. Since 9160, every recession has been preceded by an inverted 3-month/10-year yield spread, with only one false alarm in 1966. This isn’t just a phenomenon in the U.S. As of 2024, 14 economies worldwide have inverted yield curves, demonstrating global slowdown fear. Despite these warning signs, the American economy has defied this expectation.
Why No Recession Yet?
Fed Policy Pivot: Unlike in the past, the Fed has already begun easing monetary policy sooner than normal. Historically, rate cuts only occur after a recession is underway, but in this cycle, rates have been cut after growth has continued. Preemptive rate cuts have helped unwind this inversion. This early pivot may have affected the yield curve’s usual recession indication.
Economic Resilience: The real economy has proven to be stronger than anticipated. Job growth, consumer spending, and general investment have surpassed expectations into 2025. Unemployment remains quite low, supporting incomes and confidence. Despite equities tumbling in Q1 2025, they have rebounded, now reaching previous all-time highs. This market action is inconsistent with investors bracing for a near-term recession, suggesting that the soft landing proposed by the Fed is achievable.
Lagging Effects and Credit Tightening: The yield curve may be an early predictor. The massive interest rate hikes of 2022-2023 may be taking longer to hit the economy. Banks tightened lending standards after higher rates, which could strain credit lending to businesses and consumers. Historically, recessions aren’t averted until the curve completely normalizes. In the last 4 economic cycles, the yield curve has returned positive only about 6 months before a recession hit. With that understanding, a recession could still take place by late 2025.
The recent version offers hope that the U.S might escape a potential recession, but it’s no guarantee. The yield curve’s near flawless track record isn’t to be dismissed lightly, even if the timing is unclear. The U.S economy’s resilience has brought some assurance in a time of worry.