Why I watch the yield curve.
The yield curve is a predictor of recessions that has worked for 70 years. Here is how it works.
I check the yield curve every Monday morning. Not because I trade bonds, and not because I think I can time the market. I check it because it is one of the cleanest signals of collective economic expectation available in real time.
What the curve tells you
When short-term rates are higher than long-term rates — an inverted curve — it means the bond market collectively believes that rates will fall in the future, which usually means it believes that growth will slow.
What it doesn’t tell you
It doesn’t tell you when. The lead time between inversion and recession has ranged from six months to two years in historical data. Using it as a trading signal is difficult. Using it as a background assumption is useful.
The bond market is not always right. It is, however, always paying attention.
How I use it
I use it as a prior. When the curve is inverted, I am less surprised by weakness in risk assets. When it is steep, I update toward optimism about the next twelve months. I don’t act on it directly — I use it to calibrate the confidence I assign to other views.