Last week we looked at how stock-bond correlation has shifted from reliably negative to near zero — a development that undermines the foundational assumption behind the traditional 60/40 stock/bond portfolio.

This week: we’ll look at a second signal that systemic fund managers commonly rely on for early warnings of possible regime shift: the yield curve. And right now, a lot of people could be misreading it.

The natural state of the universe is that the yield curve should exhibit a gentle upward slope or curve. After all, it is truly right and just, always and everywhere, that bondholders should receive a few basis points of risk for taking on longer durations.

But as we entered 2025, the U.S. had just emerged from one of the longest periods of yield curve inversion in market history: 25 consecutive months, with a few short blips. That’s among the longest sustained upside-down periods for bond yields we've seen since the 1970s.

As I write this in late February, 2026, The 10-year Treasury sports a yield of 4.08%, while the 2-year yields 3.48%. That puts the “2-10 spread” at roughly +60 basis points… a relatively normal looking upward slope… and as the graph below shows, spreads widened significantly over the past six months, as the 2-year yield plummeted faster than the 10-year.

Meanwhile, equities are stacked up at near all-time highs. And valuations are optimistic, to say the least.

Historically, yield curves normalizing after a long period of inversion has been a recession indicator. Since Nixon was President, every time the 10Y-2Y curve has been inverted for more than three months, we’ve had a recession follow within 3 to 13 months after the normalization.

So the recession indicator is the reset, not the inversion.

But this time around… that didn’t happen. At least so far.

The curve un-inverted in December 2024. We are now in February 2026 — roughly 14 months into that window.

But look at the sudden downward move for the two-year! And the rest of the short end! Short-term yields are falling much faster than long-term yields. This is what econometricians call a bull steepener.

This is usually seen to indicate that the market pricing in Fed rate cuts. Why? Because they expect the Fed will detect signs of a weakening economy.

We saw this phenomenon precede the recessions of 1990, 2000, 2008, and 2020. And while systematic funds tend not to be public about their moves while they’re still making them, they historically read a bull steepener as a signal to pull in their horns, and reprice risk.

Do indicators like the normalization of a yield curve represent a hard signal that recession is nigh? No. And it didn’t happen this time within the 3-13-month timeline that has been the norm.

The increasing stock-bond correlations we examined last week aren’t a hard signal either.

Nor is the VIX, the so-called “fear index.”

What indicators like the yield curve and changes in correlation matrices do is shift the probability distribution.

So when the yield curve behaves exactly as it's behaving now, the base probability for recession within the following 12 months is meaningfully higher than at other points in the cycle.

Viewed alongside last week's stock-bond correlation shift, the sudden steepening of the yield curve becomes harder to dismiss. In a normal macro environment, rising stock-bond correlation is an anomaly. But taken together, these two signals warrant paying close attention.

Now may be time to dial down the risk:

These aren't recession predictions. They're responses to a shift in the risk environment — the kind of shift that should prompt any serious investor to review their own assumptions.

The yield curve isn't predicting a crash. It's telling you the rulebook may be changing. That's exactly when systematic funds pay closest attention.

Until next time,

The Navigator