The 2-year and 10-year Treasury rates provide helpful insights into near-term economic conditions.

Upward sloping trends

Upward sloping 2-yr/10-yr Treasury rates generally signal periods of economic growth, which increases inflation fears. This pattern is normally seen later in a business cycle when the economy is running hot. Investors prefer riskier assets during such periods. To entice investors to purchase Treasuries, the government sells them at a discount, increasing their yields. The increased yields help to offset inflationary fears, which also makes the Treasuries more attractive to investors.

Chart A shows the 2-yr/10-yr Treasury rates prior to the 2007 - 2009 recession. This was the last true business cycle recession that we had. The 2020 recession was caused by the Covid-19 economic shutdown and was not a typical recession. Studying economic conditions prior to the 2007 - 2009 recession and other business cycle recessions is more helpful for understanding how business cycle recession occur. 

In Chart A, the A lines show the increase in the 2-yr/10-yr Treasury rates that resulted in the inversion of the 2-yr/10-yr yield curve prior to the 2007 - 2009 recession. The inversion occurred because short-term rates increased faster that long-term rates as investors preferred holding riskier investments as the economy continued to expand. In addition, investors expected higher yields to offset higher inflation expectations. Lastly, the Fed was pushing up the Federal Funds Rate (FFR) due to inflation worries. Increases in the FFR have a greater influence on short-term rates, putting more upward pressure on 2-year rates. The combination of investor preferences and the influence of an increasing FFR pushed the 2-year Treasury rate above the 10-year Treasury rate, inverting the yield curve. 

Chart A

Downward sloping trends

In Chart A we also see what generally happens after the yield curve inversion ends and the economy begins to slow. The D lines show the 2-yr/10-yr Treasury rates decreasing until the recession hit. Downward sloping rates indicate that investors are worried about the economy and are moving into safer investments, such as Treasuries. The movement into safer investments lowers Treasury yields, and more so for short-term Treasuries as they hold less risk. Consequently, short-term yields decrease faster than long-term yields. 

Recessions (gray shaded area) occur when the 2-year and 10-year Treasury yields are decreasing, the pattern that signals investor are worried about the economy. 

Consistent patterns

The patterns shown in the 2-yr/10-yr Treasury rates prior to the 2007 - 2009 recession are consistent with those seen prior to the 2001 (Chart B) and 1990 - 1991 (Chart C) recessions. 

Chart B

Chart C