Last week, the gap between short- and long-term U.S. Treasury yields narrowed to its lowest level in a year and a half, raising prospects that a yield curve inversion might occur.

Last week, the yield spread between the 2-year and 10-year U.S. Treasuries narrowed to 17 basis points (1 bp = 0.01 percentage points).

This is the smallest margin since early 2025.

This narrowing of the yield spread increases the possibility of an inversion, where the 10-year yield falls below the 2-year yield.

This is drawing attention because yield inversorts have historically been regarded as a strong signal of an economic recession.

There have been eight economic recessions in the U.S. since the 1960s, and all of them were preceded by a yield curve inversion.

However, evaluations suggest that the predictive power of this indicator has recently declined.

This is because even when multiple yield curves inverted in 2022 and the majority of experts projected a recession within 12 months, a downturn did not actually materialize.

Nevertheless, Bloomberg interpreted that an inversion, or getting close to one, is essentially a signal that the bond market views the Fed's rate hikes as powerful enough to weigh on the economy.

If this happens, it could have widespread repercussions across financial markets, particularly the stock market, which is currently at all-time highs.

Zach Griffiths, senior macro strategist at research firm CreditSights, said, "The inversion or rapid flattening of the yield curve between the 2-year and 10-year Treasuries casts doubt on the prevailing perception that the economy is very strong, and these concerns are being reflected in the bond market."

Since 2024, the global yield curve has shown a normalization trend.

This is because investors demand higher yields as compensation for locking up their funds for longer periods.

Until last month, long-term yields surged as confidence in the Fed's ability to curb inflation under Chair Kevin Warsh eroded.

However, the situation reversed after the Fed raised interest rates in September.

Short-term Treasury yields, which are most sensitive to the Fed's benchmark rate policy, rose much faster than long-term yields.

Investors are betting that the Fed will raise rates at least three times over the next year.

Some believe that the yield curve will not invert anytime soon because a significant level of rate hikes has already been priced into the market.

Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, forecasted, "The market has already priced in expectations for substantial rate hikes by the Fed, which has caused the yield curve to flatten rapidly in recent weeks. Considering this, the yield curve is likely to steepen again in the coming weeks."

It is also difficult to anticipate that the economy will contract sharply.

According to a recent Bloomberg monthly survey, economists have revised upward their forecasts for U.S. third-quarter growth, reflecting robust demand.

On the other hand, some views hold that the curve-flattening trend will persist.

Ed Al-Hussainy, a portfolio manager at Columbia Threadneedle, stated that he is positioning for potential inversions of the 2-year to 10-year and 5-year to 30-year Treasury yield curves within the next six months as the Fed implements tightening policies to cool the economy and inflation.

He said, "The surest sign that monetary policy is shifting to a tighter stance is the flattening of the yield curve, and ultimately, an inversion."

Jamie Patton, co-head of global rates at TCW Group, pointed out, "A yield curve inversion would be a sign that the Fed is making a policy mistake. The Fed is hiking rates too much and will have to cut them significantly down the road. Therefore, a yield curve inversion is not a healthy signal for the macroeconomy."

(Photo: AP, Yonhap News)