Inverted Yield Curve Basics

Everyone’s talking about the inverted yield curve and how it could signal a recession. Robert Tipp, chief investment strategist and head of global bonds for PGIM Fixed Income, addresses some of today’s frequently asked questions.

September 03, 2019

What is an inverted yield curve?

An inverted yield curve is when yields on long-term Treasury securities are lower than yields on short-term securities. Most of the time, yields on cash, money market funds, bank deposits and short-term Treasurys are lower than long-term Treasurys such as 10-year, 20-year and 30-year bonds. But there are times in the business cycle when short-term interest rates are higher than long-term Treasurys, and that’s called an inverted yield curve.

For illustrative purposes only.

Why is everyone talking about it?

Historically, inverted yield curves have often preceded economic slowdowns. So investors have been conditioned to worry about the onset of an inverted yield curve as potentially signaling the possibility of a recession and downdraft in the markets.

Source: US Department of the Treasury. There is no guarantee that he projection shown would be achieved.


The visual shows 2 lines. The first gray line charts the differential between the 10-year and 2-year U.S. treasury yields from 1990 through August 2019. The second blue line charts the cumulative growth of the S&P 500 Index from 1990 through August 2019. The call out box in the chart states, “Historically, when the yield curve is inverted, there exists a high correlation with a market downturn. There are dark red shading on the 10-year/2year yield differential line chart to signify when the yield curve is inverted and dark blue shading on the S&P 500 line graph.


Why is this happening?

Two opposing factors caused the inverted yield curve. First, over the past few years, the Fed pushed short-term rates up about 2%. Second, long-term rates have fallen, pushing them a bit below the short-term rate, inverting the yield curve. While in past cycles the drop in long-term rates signaled investors’ concerns about a slowing economy, this time the drop in long-term rates has likely been exaggerated by the low level of foreign interest rates. Negative long-term rates in Europe and Japan have likely resulted in above-average demand for U.S. long-term bonds. This demand has likely pushed down long-term U.S. rates and contributed meaningfully to the inversion of the yield curve.

Is a recession coming?

While we can’t be sure, in our view the odds of a recession currently look quite low. The economy is growing reasonably well. The Fed has reversed course after its modest hiking cycle and is trying to foster growth by cutting rates. Unlike past inversions, interest rates are quite low—probably low enough to boost growth after their recent decline.

How is PGIM responding to the inversion?

We continue to be guardedly optimistic that we’re not facing an imminent recession. So we are taking advantage of opportunities in the market to get incremental yield in sectors we think will benefit from this economic environment of ongoing moderate growth and stable inflation.

Should individuals be making any financial moves?

Investors always face uncertainty. The best course is usually to stick with your long-term strategy and not make ad hoc adjustments based on the latest news headlines. At PGIM Fixed Income, we believe that’s the case today as much as ever. But you should talk to a financial professional about your own situation before making any moves.



These materials are for informational or educational purposes only. The information is not intended as investment advice and is not a recommendation about managing or investing assets. In providing these materials, PGIM is not acting as your fiduciary. These materials represent the views, opinions and recommendations of the author(s) regarding the economic conditions, asset classes, securities, issuers or financial instruments referenced herein. Distribution of this information to any person other than the person to whom it was originally delivered and to such person’s advisers is unauthorized, and any reproduction of these materials, in whole or in part, or the divulgence of any of the contents hereof, without prior consent of PGIM Fixed Income is prohibited. Certain information contained herein has been obtained from sources that PGIM Fixed Income believes to be reliable as of the date presented; however, PGIM Fixed Income cannot guarantee the accuracy of such information, assure its completeness, or warrant such information will not be changed. The information contained herein is current as of the date of issuance (or such earlier date as referenced herein) and is subject to change without notice. PGIM Fixed Income has no obligation to update any or all of such information; nor do we make any express or implied warranties or representations as to the completeness or accuracy or accept responsibility for errors. All investments involve risk, including the possible loss of capital. These materials are not intended as an offer or solicitation with respect to the purchase or sale of any security or other financial instrument or an y investment management services and should not be used as the basis for any investment decision. No risk management technique can guarantee the mitigation or elimination of risk in any market environment. Past performance is not a guarantee or a reliable indicator of future results and an investment could lose value. No liability whatsoever is accepted for any loss (whether direct, indirect, or consequential) that may arise from any use of the information contained in or derived from this report. PGIM Fixed Income and its affiliates may make investment decisions that are inconsistent with the recommendations or views expressed herein, including for proprietary accounts of PGIM Fixed Income or its affiliates.

The opinions and recommendations herein do not take into account individual client circumstances, objectives, or needs and are not intended as recommendations of particular securities, financial instruments or strategies to particular clients or prospects. No determination has been made regarding the suitability of any securities, financial instruments or strategies for particular clients or prospects. For any securities or financial instruments mentioned herein, the recipient(s) of this report must make its own independent decisions.

PGIM Fixed Income is a unit of PGIM, Inc. (PGIM), a registered investment advisor. PGIM is a Prudential Financial company. © 2019 Prudential Financial, Inc. and its related entities. PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.

1025736-00001-00 Ed:8/19For compliance use only


Consider a fund's investment objectives, risks, charges and expenses carefully before investing. The prospectus and the summary prospectus contain this and other information about the fund. Contact your financial professional for a prospectus and the summary prospectus. Read them carefully before investing.

An investment in our money market funds is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the funds seek to preserve the value of your clients investment at $1.00 per share, it is possible to lose money by investing in the funds.

Mutual fund investing involves risk. Some mutual funds have more risk than others. The investment return and principal value will fluctuate and investor's shares when sold may be worth more or less than the original cost. Fixed income investments are subject to interest rate risk, and their value will decline as interest rates rise. Asset allocation and diversification do not assure a profit or protect against loss in declining markets. There is no guarantee a Fund's objectives will be achieved. The risks associated with each fund are explained more fully in each fund's respective prospectus. Consult with your attorney, accountant, and/or tax professional for advice concerning your particular situation.

This material is being provided for informational or educational purposes only and does not take into account the investment objectives or financial situation of any client or prospective clients. The information is not intended as investment advice and is not a recommendation about managing or investing your retirement savings. Clients seeking information regarding their particular investment needs should contact a financial professional.

Investment products are distributed by Prudential Investment Management Services LLC, a Prudential Financial company, member SIPC. Separately Managed Accounts are offered through our affiliates. Jennison Associates and PGIM, Inc. (PGIM) are registered investment advisors and Prudential Financial companies. QMA is the primary business name of QMA LLC, a wholly owned subsidiary of PGIM. PGIM Fixed Income and PGIM Real Estate are units of PGIM. © 2020 Prudential Financial, Inc. and its related entities. Jennison Associates, Jennison, PGIM Real Estate, PGIM and the PGIM logo are service marks of Prudential Financial, Inc. and its related entities, registered in many jurisdictions worldwide.

Prudential Financial, Inc. of the United States is not affiliated in any manner with Prudential plc, incorporated in the United Kingdom or with Prudential Assurance Company, a subsidiary of M&G plc, incorporated in the United Kingdom.

Investment Products: Are not insured by the FDIC or any other federal government agency, may lose value, and are not a deposit of or guaranteed by any bank or any bank affiliate.