• Multi-Asset & Macro
  • Economic Research

Mind over matter: How we react to an inverted yield curve is more important than the inversion itself

Determining whether an inverted yield curve signals a US or global recession continues to focus the minds of investors in 2019. Mark Robertson explains why our actions will matter more in determining whether a recession is on the horizon than a misleading indicator.

3 minute read

Woman Wearing Brainwave Scanning Headset Sits in a Chair In the Modern Brain Study Laboratory/ Neurological Research Center. Monitors Show EEG Reading and Brain Model

For the first time since 2007, the two-year/ten-year Treasury yield spread turned negative on August 14, once again reviving fears of a recession. Given that previous yield curve inversions have preceded each of the past five recessions since the early 1980s, these concerns are understandable.

Figure 1: US yield curve inversion: 10yr UST – 2yr

US yield curve inversion: 10yr UST – 2yr
Source: Macrobond

The recent inversion, alongside a new record low 30-year bond yield, have followed the intense bull-flattening trade seen since the end of July. These, in turn, have been driven by fears around escalating trade war risks and a weaker global growth outlook. The market is pricing in lower odds that this is a mid-cycle downturn and higher odds it could be the beginning of a recession.

Predictive signals have always held a seductive allure in financial markets. However, while an inverted US yield curve undoubtedly conveys a feeling of unease among investors, it should be remembered recessions are not that common. This means it is statistically impossible for any single recession indicator to be robust. Worse still, the unprecedented quantitative easing (QE) interventions of the last decade may have impaired the yield curve’s signaling capacity. After all, flatter yield curves are a natural consequence of developed market central banks’ use of QE to intentionally lower long-term yields in an effort to foster investment and consumption.

History also reminds us the threat is not necessarily imminent. Empirical research from Oxford Economics, a consultancy, shows that over the past five recessions the lead time between inversion and the onset of recession has averaged approximately 21.5 months. Indeed, the range of the lead time is quite wide, spanning from 10.5 months ahead of the 1981-1982 recession to 36 months ahead of the 2001 recession.1

Nothing to fear but fear itself

Uncertainties regarding timing and signaling quality aside, how investors behave will be key. When economic agents’ expectations for the future shift sharply downwards, either due to new information that negates the prior belief or due to an external shock, this causes a contraction in demand and spending. Aggregated up, it can be disastrous as the multiplier effect works in reverse: the reduction of one agent’s spending leads to a decline in another’s income, and compounds across the entire economy.  

The issue here is that sometimes a belief can be self-fulfilling. Biases such as loss-aversion, where investors often fear losses more than they value equivalent gains, and confirmation bias, where investors place greater weight on information that supports their thesis, can weigh on market sentiment – even when the underlying fundamentals may not warrant such a negative view. There is a real risk businesses and consumers take the yield curve inversion as a sign of an impending recession, raise their precautionary savings and lower investment spending; thereby triggering the recessionary conditions they were seeking to avoid.

Who to believe: bonds or equities?

Paradoxically, even though macroeconomic indicators have weakened and bond markets have adjusted to reflect this, many major equity indices sit close to recent highs. While this may reflect a belief in the omnipotence of central banks and their ability to protect asset prices, it is also likely  a reflection of the fact that, in a low yield world where investors still need income, equities are looking ever more attractive.

While markets have come to rely on their interventions for over a decade, there is only so much that central banks can do to restore confidence once they are at, or through, the zero-lower bound. This is the difficulty faced by the European Central Bank and the Bank of Japan as they seek to revive the animal spirits of investors, consumers and businesses.

Global equities have moved in tandem with the yield curve moves this year, shedding around two per cent on the day the curve momentarily inverted on August 14.

Figure 2: Moving in sync: Global equities and the US yield curve

Moving in sync: Global equities and the US yield curve
Source: Bloomberg as at 29 August 2019

Though notable, daily sell-offs of this of this magnitude are not an anomaly. The unintended repercussions of rhetoric relating to yield curve inversion and recession fears could dampen market sentiment, individuals’ income expectations and ultimately consumption and investment.   

Such fears seem overplayed, however. A US recession is unlikely on a medium-term horizon with GDP continuing to grow above its potential, monetary policy uncertainty receding and a strong labour market, all of which have boosted consumer confidence.

Political risk remains the big threat to global growth, whether emanating from the US-China trade war, Brexit, or other geopolitical risks that reside in the background before taking their place at the forefront of investor concerns. Absent this political uncertainty, especially around the US-China trade war, it is likely business confidence and investment would be higher and the fears around a recession would be lower.

The latest yield curve inversion should therefore be seen as a warning sign, not a reason to panic.


  1. Oxford Economics - Research Briefing | US: “Despite curve inversion, don’t write off the economy yet”. John Canavan 14th August 2019

Related views

Important information


Except where stated as otherwise, the source of all information is Aviva Investors Global Services Limited (AIGSL). Unless stated otherwise any views and opinions are those of Aviva Investors. They should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. Information contained herein has been obtained from sources believed to be reliable, but has not been independently verified by Aviva Investors and is not guaranteed to be accurate. Past performance is not a guide to the future. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested. Nothing in this material, including any references to specific securities, assets classes and financial markets is intended to or should be construed as advice or recommendations of any nature. Some data shown are hypothetical or projected and may not come to pass as stated due to changes in market conditions and are not guarantees of future outcomes. This material is not a recommendation to sell or purchase any investment.

The information contained herein is for general guidance only. It is the responsibility of any person or persons in possession of this information to inform themselves of, and to observe, all applicable laws and regulations of any relevant jurisdiction. The information contained herein does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorised or to any person to whom it would be unlawful to make such offer or solicitation.

In Europe, this document is issued by Aviva Investors Luxembourg S.A. Registered Office: 2 rue du Fort Bourbon, 1st Floor, 1249 Luxembourg. Supervised by Commission de Surveillance du Secteur Financier. An Aviva company. In the UK, this document is by Aviva Investors Global Services Limited. Registered in England No. 1151805. Registered Office: 80 Fenchurch Street, London, EC3M 4AE. Authorised and regulated by the Financial Conduct Authority. Firm Reference No. 119178. In Switzerland, this document is issued by Aviva Investors Schweiz GmbH.

In Singapore, this material is being circulated by way of an arrangement with Aviva Investors Asia Pte. Limited (AIAPL) for distribution to institutional investors only. Please note that AIAPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIAPL in respect of any matters arising from, or in connection with, this material. AIAPL, a company incorporated under the laws of Singapore with registration number 200813519W, holds a valid Capital Markets Services Licence to carry out fund management activities issued under the Securities and Futures Act (Singapore Statute Cap. 289) and Asian Exempt Financial Adviser for the purposes of the Financial Advisers Act (Singapore Statute Cap.110). Registered Office: 138 Market Street, #05-01 CapitaGreen, Singapore 048946.

In Australia, this material is being circulated by way of an arrangement with Aviva Investors Pacific Pty Ltd (AIPPL) for distribution to wholesale investors only. Please note that AIPPL does not provide any independent research or analysis in the substance or preparation of this material. Recipients of this material are to contact AIPPL in respect of any matters arising from, or in connection with, this material. AIPPL, a company incorporated under the laws of Australia with Australian Business No. 87 153 200 278 and Australian Company No. 153 200 278, holds an Australian Financial Services License (AFSL 411458) issued by the Australian Securities and Investments Commission. Business address: Level 27, 101 Collins Street, Melbourne, VIC 3000, Australia.

The name “Aviva Investors” as used in this material refers to the global organization of affiliated asset management businesses operating under the Aviva Investors name. Each Aviva investors’ affiliate is a subsidiary of Aviva plc, a publicly- traded multi-national financial services company headquartered in the United Kingdom.

Aviva Investors Canada, Inc. (“AIC”) is located in Toronto and is based within the North American region of the global organization of affiliated asset management businesses operating under the Aviva Investors name. AIC is registered with the Ontario Securities Commission as a commodity trading manager, exempt market dealer, portfolio manager and investment fund manager. AIC is also registered as an exempt market dealer and portfolio manager in each province of Canada and may also be registered as an investment fund manager in certain other applicable provinces.

Aviva Investors Americas LLC is a federally registered investment advisor with the U.S. Securities and Exchange Commission. Aviva Investors Americas is also a commodity trading advisor (“CTA”) registered with the Commodity Futures Trading Commission (“CFTC”) and is a member of the National Futures Association (“NFA”). AIA’s Form ADV Part 2A, which provides background information about the firm and its business practices, is available upon written request to: Compliance Department, 225 West Wacker Drive, Suite 2250, Chicago, IL 60606.