Over the past month, the yield spread between the 10-year and two-year Treasury notes has fallen deeper into negative territory, with the yield on the two-year note currently trading nearly 0.4 percentage points above that of the 10-year note. This marks the largest inversion along this area of the yield curve since 2000, in what has historically been a reliable indicator of an impending recession. With an increasing number of economic indicators flashing warning signals in recent weeks, the deepening yield curve inversion is a sign of growing concern for the economy.
Have you ever wondered what the difference is between Treasury bonds, notes, and bills? Treasury securities have maturities ranging from a minimum of four weeks to a maximum of 30 years. The term to maturity of a given security determines its classification. If the term to maturity is a year or less, the security is called a Treasury bill. If the maturity is between two and 10 years, it’s referred to as Treasury note. If the maturity is greater than 10 years, generally either 20 or 30 years, the security is termed a Treasury Bond.
Notes have a unique significance as the yield spread between two types of notes, typically between the 10-year and two-year notes, can suggest how optimistic investors are about economic growth. An inversion of the yield curve occurs when the yield on a longer duration security, such as that of the 10-year note, falls below that of a shorter duration security such as that of the two-year note, suggesting that investors are more pessimistic than optimistic about the near-term health of the economy.
A likely reason for this correlation is that investors fearing an oncoming recession tend to purchase longer-term Treasurys, a phenomenon referred to as a flight to quality. The increased demand for Treasurys raises prices, in turn lowering yields. This process may continue until longer-term Treasury yields fall below those of shorter-term ones, indicating that many investors anticipate rougher markets and economic conditions.
-Gabe