A crucial economic indicator flashes green, yet few take heed. Convinced it outlived its usefulness, they shun this bullish signal or dismiss it outright.
What is it? “Yield curves” – and understanding their sneaky global power gives you an advantage. Let me show you why this antiquated economic gauge has renewed energy – and what it says for stocks’ future.
For over a hundred years, the US yield curve did a bang-up job forecasting economic cycles. It graphs sovereign bond rates from three months to 10 years (or longer), left to right. When long-term rates top short-term rates, the “curve” slopes upwards to the right – historically an indication of economic expansion. The steeper the upwards slope, the better. When short rates topped long, the curve was “inverted” – usually, though imperfectly, foretelling a recession.
But why? Like an instrument on a car’s dashboard, the curve usually predicts bank lending trends. Banks’ core business is short-term borrowing (through overnight loans or deposits) to fund long-term loans, pocketing the difference. So, steeper curves mean bigger profits. Hence, when the curve is steep, banks lend eagerly, fuelling growth. Inverted curves? They sap profits banks earn on loans. So, they do not lend much. Growth staggers.
For decades, the curve rarely misfired. So most investors tracked it, especially America’s, given its global economic import. But like assuming a car’s dashboard is reality, they ignored its “under the hood” function: the lending. It worked until it didn’t.
After 2022’s stock market decline, global yield curves inverted, fuelling widespread fear of recession. The worst was yet to come, many thought. But a funny thing happened: lending grew. Recession didn’t happen – in America, Asia or Europe. Some areas had tiny gross domestic product contractions, like Germany, the Netherlands or Singapore. But they were exceptions. US and world GDP climbed. Stocks rose in shock. The curve remained inverted in 2023 and most of 2024, with stocks rising and GDP growing. Soon, most deemed the curve “broken”.
But why did it “break”? Under the hood, banks held oceans of Covid-era low-cost deposits. In 2020, lockdowns and “stimulus” payments left consumers flush with cash – much of which ended up in their savings accounts. US bank deposits ballooned 20.8 per cent year on year and another 11.7 per cent in 2021, remaining elevated throughout 2022 and 2023, echoing global trends. Eurozone deposits grew 10.8 per cent year on year.
That meant banks didn’t need to raise rates to compete for deposits. Short rates no longer reflected their costs. When yield curves inverted, banks continued lending. Economies kept growing.
Now? Largely unnoticed, yield curves have flipped positive, aiding loan profits. Partly, this stems from short-term rate cuts from the likes of the Fed and European Central Bank. With that huge Covid-era deposit base having melted away, rate cuts now actually help banks by truly lowering their funding costs. Moreover, long-term rates rose (which most investors wrongly feared), steepening the yield curve and offering more lending incentive.
Money flows freely globally, so I have long fashioned a GDP-weighted global yield curve. A year ago, global 10-year sovereign bond yields were 0.76 percentage points below three-month yields: inverted. Now, they are 0.58 percentage points above those yields: a stealthy 1.34 percentage point shift. It doesn’t singularly rule out recession or a bear market, but it is significantly bullish and explains recent trends.
America's curve steepened less, widening from a deeply inverted 1.30 percentage points below to 0.01 percentage points below, basically flat. But continental Europe’s shifted from 0.54 percentage points below to 1.22 percentage points above: a big, fat 1.76 percentage point shift. The UK’s went from 0.94 percentage points below to 0.74 percentage points above.
These swings matter, especially since so few notice. Japan and China, where the yield curve was not inverted a year ago, now see higher spreads. Japan’s rose from 0.76 percentage points above a year ago to 1.17 percentage points above now. China’s went from 0.68 percentage points above to 0.93 percentage points above.
Where it improved most, stocks do better. Globally, non-US stocks have outshined America’s in 2025, led by European stocks’ red-hot 26.7 per cent rise until August 25. UK stocks are up 26.3 per cent, US stocks just 10.2 per cent. Sure, tariffs hurt America the most. But the relatively steeper curve shifts in Europe and the UK adds another layer.
Steeper yield curves boost lower-growth, cheaper-value stocks. Those dominate Europe. Tech growth stocks dominate America. In the year to date, Europe’s banks rose 79.7 per cent and the UK’s 49.8 per cent, smashing US tech’s 13.5 per cent. Why? The global curve shift boosts bank profits.
Value-orientated industrials in Europe and the UK also lead, up 34.2 per cent and 36.4 per cent, respectively. More lending delivers capital to grow.
Global curve steepening alone will not dictate markets’ direction. But it is a tailwind with true power, especially because it is unseen. Expect it to drive global stocks higher, especially in Europe and the UK.
