Lesson 2
The Yield Curve (T10Y2Y): Your Economic GPS
Track the 2s10s (T10Y2Y) spread (10Y minus 2Y) daily. Inversion tells you recession risk is building. Steepening after inversion tells you recession is imminent. This is your timing indicator for defensive positioning.
📊 Indicators mentioned in this lesson (click for details):
The yield curve (T10Y2Y) is the single most important recession indicator in finance. It has predicted every US recession since 1950.
What the Curve Shows:
Plot Treasury yields from short-term (3M, 2Y) to long-term (10Y, 30Y). The shape tells you what the market expects about the future.
Normal Curve (Upward Sloping):
- Short rates < Long rates
- Banks profit: borrow short (cheap), lend long (expensive)
- Credit flows, economy healthy
- Example: 2Y at 3%, 10Y at 4.5%
Flat Curve:
- Short rates ≈ Long rates
- Banks can't profit from maturity transformation
- Credit slowing
- Late-cycle signal
Inverted Curve:
- Short rates > Long rates
- Banks LOSE money on new loans
- Credit contracts
- Market expects Fed will cut (because recession is coming)
- Example: 2Y at 5%, 10Y at 4%
The Prediction Mechanism:
Why does inversion predict recessions? Two reasons:
- Banks stop lending (it's unprofitable) → credit crunch → recession
- Inversion means markets expect Fed cuts → they expect economic weakness
The CRUCIAL Nuance:
Inversion is the WARNING. Steepening AFTER inversion is the TRIGGER.
When the curve un-inverts (10Y rising or 2Y falling), recession is typically 6-12 months away. The curve steepens because the Fed starts cutting (2Y falls) or because investors flee to safety (10Y rises). The steepening is when recessions actually BEGIN.
Check your understanding
Lesson Quiz
Quiz Check
What does an inverted yield curve (T10Y2Y) (2Y yield > 10Y yield) signal?
Quiz Check
Why is steepening AFTER inversion the more urgent signal than inversion itself?
Quiz Check
The 2s10s (T10Y2Y) spread has been inverted for 18 months. Should you expect recession immediately?