• The yield curve has begun to “uninvert,” signaling a return to more typical market conditions.
  • Recessions have often followed the normalization of the yield curve, raising questions about whether the current shift is a sign of trouble. 
  • Stock market corrections can accompany recessions, which makes it critical for investors to monitor the yield curve. 


For more than two years, the yield curve has been sending mixed signals, a perplexing pattern that left markets on edge. Typically, when short-term interest rates rise above long-term rates, it’s a sign that a recession is likely on the horizon. That’s why yield curve inversions are historically a red flag—a warning that trouble is brewing in the economy. But despite this inversion in rates, the U.S. economy has shown surprising resilience, defying expectations as the yield curve remained stubbornly inverted through 2023 and much of 2024. 


Now, as we enter 2025, a shift is unfolding. The yield curve has begun to “uninvert,” with long-term rates once again surpassing short-term rates. At first glance, this normalization might seem like a sign the worst is behind us. But history reminds us that the return to a typical yield curve doesn’t always signal recovery. In fact, it’s often the calm before the storm. So, the real question for investors is whether this time will be different and what the latest shift in the yield curve means for the markets. 


Why the yield curve matters right now


In 2022, the yield curve—a key economic barometer—flipped into inversion, a rare and unsettling event that typically signals an increasing risk of recession. The yield curve usually slopes upward in a healthy economy, reflecting the simple fact that long-term bonds offer higher yields than short-term ones. That makes sense: Lenders demand a premium for taking on the added uncertainty of longer-term loans.


However, when this pattern flips it’s known as a yield curve inversion. And this shift has often been a powerful predictor of recessions. According to Barron’s, five of the last six recessions (going back to 1980) were preceded by an inversion of the yield curve. That led many economists and analysts to start preparing for an economic downturn when the curve inverted in 2022.

The inversion was partly driven by the Federal Reserve’s aggressive interest rate hikes, aimed at curbing inflation. By raising short-term rates, the Fed created a scenario where yields on short-term government debt, like the two-year Treasury note, exceeded those for longer-term debt such as the 10-year Treasury note. This inversion persisted into 2024, leading to a perplexing situation: The bond market was signaling a potential economic contraction, yet the U.S. economy continued to defy those expectations.


Understanding the latest “uninversion”


In recent months, the yield curve has begun to “uninvert.” That means the spread between short-term and long-term yields has started to normalize, with longer-term yields now exceeding short-term yields. At its peak, the two-year Treasury yield was as much as 159 basis points higher than the 10-year yield. 


Today, the 10-year yield trades around 4.51%, while the two-year yield is at 4.21%. This indicates the bond market’s expectations are changing. But does that mean the economy is no longer in danger of falling into recession? Not necessarily. 


A normalizing, or uninverting, yield curve can actually signal deterioration in the economy is imminent. While the initial inversion is usually seen as a warning, the “uninversion” has often marked the start of the downturn. In short, the yield curve’s shift back to a positive slope doesn’t mean recession risks have faded—if anything, it may signal they’re intensifying. This is reflected in the historical pattern shown below.

gov.uk

A wrinkle in the 2025 narrative


A twist in the 2025 narrative deserves attention. Historically, when the yield curve shifts back to a positive slope, it’s usually accompanied by a decline in the 10-year Treasury yield. It typically occurs because the Federal Reserve cuts rates in response to a slowing economy, which pushes down longer-term yields. 


This time, however, the 10-year yield has moved in the opposite direction. Since mid-September 2024, it has risen from 3.65% to 4.51%, briefly peaking at nearly 4.80%. Some analysts attribute this shift to the pro-business policies of the Trump administration, which could drive stronger-than-expected economic growth. This outlook was supported by the Federal Reserve’s decision to hold benchmark rates steady during its January policy meetings, signaling a greater concern over an overheating economy than a weakening one.


So, what does it all mean? Three scenarios seem possible. First, the rise in long-term yields could suggest a recession is delayed, with rates remaining elevated for a longer period. Alternatively, the rising 10-year yield may be a false signal, and a recession could still be imminent. Finally, it’s possible this is a rare instance where a yield curve inversion doesn’t accurately predict a recession, and the economy manages to avoid a downturn altogether.


Near-term developments may provide further clarity


The road ahead is far from clear, but the coming months should provide clarity. As the yield curve evolves, it holds more than just theoretical significance—it has become a practical guide for investors. Shifts in the curve will provide crucial insight. Is the economy falling into recession, or are we witnessing the start of a surprising growth phase, defying all expectations?


The implications are far-reaching. Historically, recessions have sent shock waves through the stock market. Given that the yield curve has long been one of the most reliable indicators of economic health, its movements in the months ahead will help shape market sentiment. Whether the economy veers into contraction or surprises with a soft landing, investors will need to adapt, making informed decisions to manage risk efficiently. 


To learn more about interpreting yield curves—and trading interest rates—readers can check out this episode of Options Jiveon the tastylive financial network

Andrew Prochnow has more than 15 years of experience trading the global financial markets, including 10 years as a professional options trader. Andrew is a frequent contributor Luckbox magazine.

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