For the first time since 2006, the US treasury bond yield curve became inverted on Monday, flagging concerns of an impending slowdown or even a recession. Just like the last inverted bond yield curve warned of the Lehman Brothers crisis in 2008, market observers feel this time too, the inverted curve signals a crisis ahead.

The concerns of a looming economic slowdown were triggered after the bond yield on the 5-year treasury note rose to 2.6361 percent on Monday but the returns on the 30-year bond slipped to 2.6004 percent. While the indicators reversed within a few hours with the yield on long-term bonds becoming marginally higher than that on the short-term bonds, several experts are taking this brief development as a sign of an imminent economic slowdown.

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Meanwhile, rising inflation and the ongoing Russia-Ukraine war have further raised market nervousness concerning the potential for an economic slowdown.

What’s the correlation between bond yields and economic outlook?

The performance of bond yields (short- and long-term) is considered to be a good indicator of how the economy is doing as the bond market is mostly driven by future economic growth outlook. As people who put money into the bond market look to the future in choosing what to invest in, bond yields have a strong track record of being an instrument to predict what the economy will look like in the near future.

How is the bond yield curve used to predict future economic growth?

Bonds have a maturity period ranging from one month to 30 years. Naturally, investors expect higher returns for holding longer-term bonds (more than two years) and lower returns on short-term bonds (two years or less). Therefore, the bond yield curve is said to be inverted when short-term bonds start offering more returns than their longer-term counterparts.

When long-term bond yields increase faster than short-term ones, investors see stronger growth ahead. On the contrary, when returns on short-term bonds rise faster than the yields on long-term bonds, investors see slowing growth ahead.

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Only in rare occurrences, does the curve become inverted — i.e., short-term bond yields are higher than long-term bond yields — but such a scenario suggests that investors fear a recession ahead.

Is the bond yield curve always an accurate economic indicator?

It is certainly a strong indicator but the bond yield pattern doesn’t guarantee 100 percent accuracy in predicting economic growth in the future. There are factors other than the future growth outlook which may dictate the bond yield curve. These include the bond-buying policy of the US Federal Reserve, GDP, interest rates, inflation, industrial output, and the balance of trade, among others. Thus, it is suggested to take the readings of the bond yield curve with a grain of salt.

(Edited by : Thomas Abraham)