A deep analysis of the most debated market signal through US history, current data and emerging uncertainties.
Oct 1, 2025
Alessandro Mazzarini
For over half a century, the inversion of the US Treasury yield curve – in particular the spread between 3-month and 10-year bonds – has established itself as one of the most reliable indicators for anticipating recessions in the US economy. Historically, each inversion has been followed by a contraction in economic activity with a lead time of between 6 and 24 months.
The logic is simple: when short-term yields exceed long-term yields, the basic principle of the “normal” curve, which rewards maturity with higher yields, is broken. It is a symptom of a system that prices in future instability and imminent risk repricing.
Yet, in July 2025—more than 20 months after the last inversion—the US economy continues to grow at a real annual rate of close to 2%. The question, at this point, is: does the yield curve still function as a predictor of recessions?
Inversion mechanism: two opposing forces
The inversion of the curve reflects an imbalance between two interdependent dynamics:
Reactive monetary tightening: faced with accelerating inflation, the Federal Reserve intervenes by raising short-term rates, over which it has direct control. The aim is to curb demand and stabilize prices.
Market anticipation of the cycle: in a context of growing uncertainty, investors recalibrate their expectations and take refuge in long-term Treasuries. These assets, in the event of future monetary expansion, are safer and potentially more profitable due to capital gains.
The result of these opposing forces is a compression of the spread between short- and long-term rates. Short-term yields rise as a result of the Fed's actions, while long-term yields fall due to increased demand. When the curve inverts, it signals not only a technical anomaly, but also a fracture in the confidence of a segment of market participants regarding the future economic trajectory. It is a symptom of a misalignment between the expectations of the most attentive investors and the climate of optimism that still pervades the market as a whole.
Why does the curve normalize before the recession?
One of the less intuitive but crucial aspects of the curve's dynamics is that its “recovery”—i.e., its return to a positive configuration—occurs before the onset of the actual recession. This does not contradict its predictive validity but clarifies its sequential behavior.
As tangible signs of macroeconomic deterioration emerge (e.g., rising unemployment, compression of corporate margins), the market stops looking at the long term and repositions itself on short-term securities, discounting an imminent rate cut. This movement causes a decline in short-term yields and, consequently, a “normalization” of the curve.
The sequence of the inversion, in three operational stages:
Forecast phase – Investors anticipate the slowdown: they buy long-term Treasuries → long-term rates fall → the curve inverts.
Confirmation phase – Macroeconomic weakness manifests itself → rotation towards short-term securities → short rates fall → the curve readjusts.
Full-blown recession phase – The Fed intervenes → effective rate cuts, expansion of demand for government debt → general flattening of the curve.
The current cycle: a structural anomaly?
The post-COVID cycle has created an atypical macroeconomic environment. The reversal that began in the second half of 2022 continued until mid-2024, lasting a record amount of time. However, no recession has yet materialized. Real output continues to grow, consumption remains resilient, and traditional pre-recessionary signals appear weak or delayed.
Two variables help explain this resilience:
Labor market: The unemployment rate remains around 3.5%, close to historic lows. Unlike previous recessionary cycles (2001, 2008), in which the curve inverted in conjunction with an already weakened labor market, the current phase has developed in a still-expansive employment environment. Only recently has there been a cooling off: job offers have fallen by 30% compared to the peaks of 2022.
Corporate profitability: US companies continue to report high margins. After peaking in Q4 2023, levels have stabilized with no obvious signs of contraction. In typical pre-recessionary phases, falling margins are one of the first warning signs. In this cycle, there has been no such sign so far.
A mechanical, not psychological, reversal
The emerging hypothesis among analysts is that the recent reversal has been largely “mechanical.” After a long period of near-zero rates, the result of the post-COVID monetary response, the Fed has embarked on the fastest cycle of rate hikes since the 1980s to contain runaway inflation. This shock has pushed short-term rates up very quickly, while long-term yields have remained relatively stable, reflecting rational expectations rather than panic.
The curve, therefore, would have inverted more as a direct effect of monetary policy than as a result of a profound change in market sentiment. This distinction is fundamental: an inverted curve is not always synonymous with systemic uncertainty.
Is the yield curve still a valid indicator?
The answer is not binary. Macroeconomic dynamics have always been resistant to rigid patterns, and the growing complexity of economic contexts inevitably makes it more difficult to interpret traditional indicators. In particular, predictive analysis today suffers from two structural weaknesses: the multiplication of information flows – often redundant or contradictory – and the interpretative relativity of the available data. In this context, deeper theoretical considerations also come to the fore: as suggested by N. N. Taleb, some events – the so-called “black swans” – appear fully explainable only ex post, making the analysis of fundamentals the victim of a fallacious retrospective rationalization that struggles to sustain itself from a predictive perspective.
Without falling into fatalistic or philosophical drifts, it is useful to recognize that no indicator can aspire to offer certainties. The yield curve is no exception. Yet precisely because it reflects the interaction between expectations, confidence, and the actual behavior of operators, it remains a valuable compass – especially for capturing misalignments between the dominant narrative and the more thoughtful assessments of attentive investors.
More than a causal mechanism, the curve today represents an alert system: a barometer sensitive to points of friction between macro reality and future expectations. In this sense, the fact that the recession has not (yet) materialized may not disprove the signal but only indicate that we are still in the middle phase of a longer and less linear cycle than expected.