The backstory: The yield curve is widely used as a predictor of future recessions. Generally, it shows when there’s a divergence between the outlook of the Fed and traders on future economic conditions.

When the curve starts to become inverted — or when the Fed believes short-term growth will be strong, while long bond traders and investors believe economic growth is slowing — it’s a sign that a recession could be in the cards.

What’s going on: The yield curve has been flattening; if it inverts, it could trigger a correction in the equity market. Check out the U.S. Treasury real yield curve rates over the past three years:

Source: Quandl

There’s still plenty of room to go before the yield curve is inverted; even if the curve starts to invert, a recession and market correction would take some time to materialize, months to a year or so after that kind of catalyst.

What to watch for: I expect the stock market to go higher and run up into 2018. But I’ll keep an eye on the yield curve and look for any clues in the bond market that could signal a downturn. If and when we see an inverted yield curve, I’ll be ready to make some bearish bets; until then, I’ll be patient and wait for a clear signal.

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Jeff Bishop is lead trader at TopStockPicks.com and is co-founder of RagingBull.com. He runs short-term trading strategies, using stocks, options and leveraged ETFs.

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