Yield curves in Germany and the US massively inverted. Will they lead to a recession?

The German yield curve hit its most inverted level since 1992. This means that the yield on short-term bonds was higher than on long-term bonds. This state of affairs is rare and may signal that investors expect worse economic conditions in the future and higher interest rates in the near future.

The yield on 2-year German government bonds, the most sensitive to interest rate expectations, rose by almost 10 basis points (bps) to 3,24%. The 10-year German bond yield rose less, by 6 basis points to 2,36%, leaving the spread between them at -88,3 basis points, the most inverted curve since September 1992.

Meanwhile, in the US, the difference between 10- and 2-year bonds already reaches 97 points, which gives the most inverted curve since 1981. Moreover, according to economists surveyed by Bloomberg, this state of affairs may last even until the second half of 2024.

READ: How to invest in bonds? Beginner's guide

Why is this a dangerous phenomenon and what does the inverted curve mean?

• Recession expectations: An inverted yield curve is often interpreted as a sign of an upcoming recession. Investors anticipate worse times, a decrease in inflation and dynamics CBA.
• Decrease in credits: Banks make money by lending short-term funds and making long-term loans. When the yield curve is inverted, banks' profit margins are low or even negative, which may lead banks to reduce lending. This, in turn, can slow down investment and consumption, which has a negative impact on the economy.
• Negative Expectations: An inverted yield curve can affect market sentiment, leading to negative expectations among both consumers and businesses. This can lead to a reduction in spending and investment, which further hampers economic growth.

Keep in mind that the inverted yield curve itself is not a tool to fight inflation. Rather, it is a market signal that may indicate future economic troubles such as recession. However, an inverted yield curve can be the result of central banks raising interest rates to combat inflation, and this is currently the case.