There’s been lots of news about how the yield curve between 1yr-10yr is inverted and that a recession is to follow. But are we reading too much into the yield curve inversion this time?
Scenario 1:
With yield curve inversions typically, the longer dated bonds have lower yields and this makes sense during flight to safety when bonds actually yielded higher returns, indicating a recession.
Scenario 2:
With the bond yields starting out really low, rate increases make it more attractive to start buying the longer dated treasuries once again which lowers the yield. So the short term bonds are getting dumped more than longer term bonds since with more rate increases, the future bonds have better yields. This causes a yield inversion as well.
The mechanics seem different in the two scenarios but both can result in yield inversions:
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Where longer term bonds get bought more than shorter term as a flight to safety
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Where longer term bonds get sold less than shorter term due to potential increases in interest rates in the future
One can argue that with higher borrowing cost in scenario 2, this can cause a recession. But this could also just indicate a reset back to pre-Covid and that the yield inversion is meaningless.
Does this make any sense and am I interpreting this correctly?
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