Yield Curve
The yield curve plots government bond yields across maturities, from short bills to long bonds. Under normal conditions it slopes upward, since lenders demand extra compensation for tying up money longer.
When short yields rise above long ones, the curve is inverted, and inversion is the most watched recession signal in markets.
The math
The headline spread is one subtraction. If the 10 year Treasury yields 3.5 percent and the 2 year yields 4.5 percent, the spread is minus 1 point: inverted.
The dollar consequence is clearest for lenders, whose business is borrowing short and lending long. A bank funding itself near 4.5 percent while writing 10 year loans at 3.5 percent loses $10,000 a year on every $1 million lent.
| 2 year yield (bank funds here) | 4.5% |
| 10 year yield (bank lends here) | 3.5% |
| Spread | -1.0 point |
| Result per $1 million lent | -$10,000/year |
Multiply that across a loan book and inversion becomes a working brake on new credit, which is why the signal carries economic substance rather than being mere chart reading.
The trap
Liquidating on inversion. The lag between an inverted curve and any economic downturn is long and variable, sometimes stretching across many quarters, and equity markets can rise substantially in the interim.
Investors who go to cash on the signal often sit out significant gains waiting for a recession that arrives late, arrives mild, or resolves differently than the textbook suggested. A useful warning light makes a poor autopilot.
The move
Treat inversion as a portfolio review prompt rather than an exit order. Reexamine the cyclicals, the lenders, and any holding with a refinancing wall or a customer base that buys on credit; verify each can carry a downturn arriving on its own schedule.
Then keep owning durable businesses at sensible prices. Let the curve inform what you hold, never whether you invest.