Michelle Price and David Henry

(Reuters] – On Tuesday the U.S. Treasury yield graph, which is often used as a barometer for the state of the economy, was briefly inverted. This signaled that bond investors fear a potential recession.

Although investors should remember that the yield curve does not indicate recession but it is one of many indicators to be looking for. However, banks can find themselves in a difficult spot when trying to predict the future. The changing form of the yield curve could affect how they manage the margins between the cost and interest on their loans and securities. Also known as their net income, this is the difference between the bank’s interest and their cost of money. The yield curve inversion could have serious implications for U.S. lenders.

WHAT HAS JUST HAPPENED

For the first time in 2019, the yields of the 2-year Treasury were higher than the 10-year Treasury’s.

Investors expect to receive more compensation for taking on higher inflation risk. This is because they are willing to accept a lower expected return by owning bonds with a longer maturity. A 10-year note yields typically more than a 2-year one.

A past example of a recession-predicted inverted curve is an indicator that it could be. U.S. Federal Reserve started increasing rates, and it is likely to keep hiking aggressively through 2022.

IS IT HARMFUL FOR BANKS?

Well, sort of. The general rule is that banks lend short-term money and borrow long-term. They also make money when the curve is inclined.

Inversion of the 2-year means that there’s no spread between borrowing for 2 years and earning interest on 10 year Treasuries.

REALLY, it’s not that bad.

However, in reality, banks lend and borrow at different points of the curve. Banks tend to have average maturities less than 5 years for loans and securities.

The average borrower is only able to repay their loans in 10 years, while the other borrows less for two-year terms. Their tendency to borrow and lend less toward the short-term end of the yield curve which is steep, is why they are more inclined to do so. On Tuesday, for example, there was a spread of about 190 basis point between the 3-month- and 5-year Treasury curve yield curves.

For example, JPMorgan Chase & Co (NYSE:) funds more than half of its balance sheet with low-cost deposits, the cost of which tends to move up very slowly. In the fourth quarter, JPMorgan had a rate of 0.22% for its interest-bearing liabilities. This is quite a distance from Tuesday’s 2.4% yield for 2-year Treasuries.

In anticipation of Fed rate increases, floating-rate terms loans for commercial and industrial purposes have increased in number.

The banks have predicted that interest rate increases will significantly increase their net income this year.

A bigger danger to banks is the possibility of recession. It could impact consumer spending, and reduce Americans’ ability repay their loans.