Yields Late-Cycle Dynamics

Why Long Yields often rise into late phase of the Economic Upturn

Short vs. Long Yields – Different Drivers, Different Timing

Short-term and long-term interest rates often behave very differently over the business cycle due to their distinct drivers. Short-term yields (like the 2-year Treasury or overnight rates) are heavily influenced by Federal Reserve policy and near-term expectations[1]. When the Fed raises its policy rate, short-term yields quickly follow suit, reflecting the tighter monetary conditions. Long-term yields (like the 30-year Treasury or mortgage rates), on the other hand, are primarily driven by longer-run factors such as inflation expectations, growth outlook, and investor demand for safe assets[1]. Long-term rates do not always mirror Fed moves one-for-one; in fact, during tightening cycles it’s common for short-term yields to rise sharply while long-term yields increase more modestly, causing the yield curve to flatten or even invert[1][2]. This pattern was observed, for example, in 2022–2023 when the Fed’s rapid rate hikes lifted short yields substantially, but 30-year yields remained relatively range-bound – an expected dynamic as markets anticipated future economic slowing[2].

Such yield curve flattening (or inversion when short rates exceed long rates) is a well-known harbinger of economic trouble[3]. It reflects investor expectations that the Fed’s tight policy will eventually cool the economy (and inflation) so much that future short-term rates will be lower. However, an inverted curve is only a phase in the cycle. Eventually, as signs of economic stress emerge, the cycle enters its final stage – and that’s when the roles of short and long yields flip. Short rates peak and begin to fall in anticipation of Fed rate cuts, while long-term yields may initially hold steady or even climb due to lingering inflation fears or heavy government debt issuance. This leads to a re-steepening of the yield curve (widening spread between long and short rates), a dynamic typically seen toward the end of an expansion[4]. Importantly, this steepening – counterintuitive as it may seem – is also part of the normal cycle progression and has preceded many recessions. In fact, historical analysis shows that almost every recession starts when the yield curve steepens again, as the Fed pivots to rate cuts (driving short-term yields down) while long-term yields don’t fall as fast or even tick up[4]. In essence, the short-term end of the curve moves first on the way up, and first on the way down. Long-term rates are slower to turn, finally dropping only once economic deterioration and loosening policy firmly take hold.