The Yield Curve and What It Tells Us
The message in the front end (first two years) of the yield curve is powerful. Take a look.
Before we dive into today’s commentary, I will take a moment to share a delightful conversation I had with Jonathan Treussard for his podcast Treussard Talks. We talked about the family stories that grounded us and shaped our perspectives and careers, the importance of the study of history and my new book, Camp Kotok and its beginnings, investing principles, and more. Here’s the link:
“When History Meets Markets: Geopolitics, Civility, Capital with David Kotok” | Treussard Talks (E09)
Now let’s move on to today’s topic.
This chart from the August 13, 2025, edition of the Sevens Report offers a depiction worth at least a thousand words. We thank Tom Essaye for permission to share the chart with our readers. For details about Tom’s valuable and substantive newsletter, see https://sevensreport.com.
In the chart Tom is showing what happens when two ratios derived from the front end of the yield curve reach certain extremes and then turn. He has listed key dates. And, using FRED data, he has also marked recession periods.
Do we always get a recession? No. Do we get a slowdown? Nearly always yes. Is that happening now (2025)? Slowdown for sure. Recession? Maybe.
Tom's chart covers the entire period of declining interest rates (starting from1980) and continues through the COVID period to present. During the period he examined, the federal budget was in deficit at times and in surplus at other points. Over the 45 years examined, inflation was sometimes near zero and sometimes in the very high single digits.
The present yield curve is flashing a yellow light and warning us.
No indicator has a perfect record, but this one deserves a lot of respect.
In order to see references that offer some guidance for the present period of tariffs shocks and rising inflation, we have to look at the oil price shock of the 1970s or the dollar weakness period of the later 1980s.
Remember the 1987 stock market crash triggered by rising interest rates as then-new Fed Chair Alan Greenspan raised rates to defend the dollar. Greenspan never did that again. And the Fed, since 1987, has always ceded the dollar's hegemony to the US Treasury. Scott Bessent, this ball is in your court.
Today, we have inflation above the 2% target and rising. We have a tariff shock that is roughly equivalent to a $2 hike in the tax on gasoline. And we have a steeper federal deficit trajectory than ever before in our country’s history.
If the Fed cuts the short-term interest rate, there is no way to know what the longer-term interest rate will do. It could rise, and the entire curve could get steeper.
That steepening is just as likely to happen as a lowering of the longer-term rate.
Yellow lights flashing are caution lights. Sometimes you can cross the intersection before they turn red. But they always will turn red after flashing yellow.
That's something to think about.
Thanks again, Tom, for this excellent chart.
David values thoughtful, constructive responses from readers. To contact him, please send an email. The subject line should read “Response to [title of commentary].”
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