The Treasury yield curve has inverted before every recession since 1969, making this the longest inversion on record.
Experts are ambivalent about whether the U.S. economy is heading for a crisis. In October 2022, economists estimated a 63% chance of a recession within 12 months, according to The Wall Street Journal. At the time, inflation was over 8% and the Federal Reserve was raising interest rates at its fastest pace in decades. But the situation has changed dramatically since then.
The economy continues to expand while inflation has subsided enough that policymakers are expected to cut interest rates in September. U.S. gross domestic product grew at a 2.8% annual rate in the second quarter, but experts are predicting growth of just 2%. Economists now give the economy a 28% chance of a recession within the next 12 months. But investors aren’t out of the woods yet.
Bloomberg recently published an opinion piece by former president of the Federal Reserve Bank of New York, Bill Dudley, with a headline that says it all: “I’ve Changed My Mind: The Fed Needs to Cut Interest Rates Now.” Dudley believes the economy is already heading toward a recession and that delaying interest rate cuts until September unnecessarily increases the risks.
Bond market forecasting tools support this conclusion: The Treasury yield curve has predicted every recession since 1969, giving 21 months of warning, the longest period in history. If the warning is accurate, a recession would almost certainly lead to a stock market crash.
Image source: Getty Images.
For over 50 years, the Treasury yield curve has been a surprisingly accurate recession forecasting tool.
Treasury bills are fixed income securities that pay a fixed interest rate (or yield) based on their maturity date. Treasury bills with longer maturities usually have higher yields than those with shorter maturities because investors expect a greater return on their investment over a longer period of time. For example, a 10-year Treasury bill usually has a higher yield than a 3-month Treasury bill.
But when short-term Treasury yields exceed long-term Treasury yields, the yield curve inverts. Inversions occur frequently when economic uncertainty prompts investors to buy longer-term bonds. Because bond prices and yields move in opposite directions, increased demand for long-term Treasury bonds will drive their prices higher and their yields lower, which can lead to an inversion.
The inversion between the 10-year and 3-month Treasury bills is especially noteworthy because this portion of the yield curve has become a reliable tool for predicting economic downturns. According to the Federal Reserve Bank of New York, “the yield curve has predicted essentially every U.S. economic downturn since 1950, with only one ‘false’ signal preceding the 1967 credit crunch and slowdown in production.”
The current yield curve inversion is the longest on record, meaning the economy is “lagging” behind a recession.
Since 1969, the U.S. economy has experienced eight recessions, all of which were preceded by an inversion of the yield curve between 10-year and 3-month Treasury notes.
Yield Curve Inversion
Recession Start Date
Time has passed
December 1968
December 1969
12 months
June 1973
November 1973
5 months
November 1978
January 1980
14 months
October 1980
July 1981
9 Months
June 1989
July 1990
13 months
July 2000
March 2001
8 months
August 2006
December 2007
16 months
June 2019
February 2020
8 months
Data source: Federal Reserve Bank of New York, National Research Institute for Economic Research. The chart above shows the correlation between US economic recessions and yield curve inversions. The date of yield curve inversion corresponds to the first month that the average yield on 3-month Treasury bills exceeded the yield on 10-year Treasury bills.
As shown above, historically, Treasury yield curve inversions occur within 16 months of a recession. However, the current inversion recently became the longest on record. The inversion began 21 months ago, in November 2022, meaning the U.S. economy is “overdue” for a recession.
One other important data point: The average maturity spread (the difference between the yields on the 10-year Treasury note and the 3-month Treasury note) exceeded -1% in June 2024. The last time this happened (excluding the current inversion) was August 1981. In other words, the bond market is not only sounding the alarm bells of a recession, it is sounding the alarm bells of the deepest recession in decades.
While the S&P 500 often crashes during recessions, there are some silver linings for investors.
Historically, recessions are bad news for the stock market. The chart below shows the peak declines in the S&P 500 Index (^GSPC 0.08%) during each recession since 1969. I think it’s fair to say that in most cases, recessions coincide with stock market crashes.
Recession Start Date
S&P 500 decline peaks
December 1969
(36%)
November 1973
(48%)
January 1980
(17%)
July 1981
(27%)
July 1990
(20%)
March 2001
(37%)
December 2007
(57%)
February 2020
(34%)
Median
(35%)
Data source: Truist Advisory Services.
As shown above, the S&P 500 has fallen an average of 35% during recessions since 1969. The index is currently trading 4% below its all-time high, so if a recession were to start tomorrow, the expected decline would be 31%.
While that is alarming, the worst mistake investors can make is trying to time the market by selling stocks now and buying them back before the rebound. No forecasting tool is foolproof, so the current yield curve inversion does not guarantee a recession, nor does it guarantee a stock market crash.
Moreover, even when the stock market crashes, the S&P 500 has historically recovered before the recession ends. “In every recession over the past 50 years, except for the dot-com bust of the early 2000s, the S&P 500 started to recover to highs before economic activity bottomed out,” says JPMorgan strategist Elise Ozenbaugh. “On average, the market rally began 4.5 months before GDP bottomed, generating a 30% gain in that time.” In other words, investors trying to time the market could easily miss out on big gains.
There’s a silver lining. The S&P 500 has recovered from every recession in history, and there’s no reason to think the next one will be any different. In that sense, the next stock market crash could actually be a great buying opportunity. Some Wall Street analysts see artificial intelligence (AI) as one of the biggest investment opportunities in human history. But unbridled enthusiasm has many AI stocks trading at high prices. A stock market crash could give investors another chance.
For example, during the last bear market, shares of Alphabet, Amazon, and Microsoft fell by more than 30%, while Nvidia and Advanced Micro Devices plummeted by more than 60%. Similar declines could occur in the next market crash, allowing investors to buy shares in these AI companies at significantly lower prices than they are currently at.
Suzanne Frey, an Alphabet executive, is a member of The Motley Fool’s board of directors. JPMorgan Chase is an advertising partner of The Ascent (a subsidiary of The Motley Fool). John Mackey, former CEO of Whole Foods Market, a subsidiary of Amazon, is a member of The Motley Fool’s board of directors. Trevor Jennewine has invested in Amazon and Nvidia. The Motley Fool has invested in and recommends Advanced Micro Devices, Alphabet, Amazon, JPMorgan Chase, Microsoft, and Nvidia. The Motley Fool recommends long January 2026 $395 calls on Microsoft and short January 2026 $405 calls on Microsoft. The Motley Fool has a disclosure policy.
