The Dread "Inverted Yield Curve"

It makes brave economists cower.
By Daniel Gross
Posted Thursday, Dec. 29, 2005, at 3:44 PM ET

On Tuesday, the placid post-Christmas markets were rattled by news that interest rates on two-year bonds nudged higher than those for 10-year bonds. This was the dreaded inversion of the yield curve, and it sent the markets running. Why? Traditionally, inverted yield curves signal bad news for the economy—and hence for stocks. As the highly reliable Paul Kasriel of Northern Trust, quoted in yesterday's Wall Street Journal, put it, "this is a warning signal … that we are on recession watch now."

Recession watch? You don't have to be a jolly optimist to believe that was an overreaction. Indeed, the concern about momentary inversion of the yield curve—it has since un-inverted—is a lesson in how Wall Street can be constrained by rigid thinking.