(Bloomberg) -- The robust earnings at megabanks from JPMorgan Chase & Co. to Wells Fargo & Co. have poked holes in a popular theory: that an inverted yield curve hurts lenders and eventually leads to a recession.

The conventional wisdom, at least in some corners on Wall Street, is that banks borrow at short-term rates and lend long, so when the yield curve turns upside down, it squeezes lender margins, which eventually leads to a credit crunch.

Yet, nearly 16 months after a key part of the Treasury curve first inverted, business at the big banks is booming. While the Federal Reserve’s aggressive rate increases helped topple some regional lenders, JPMorgan posted a record profit Friday, and some of its top rivals signaled stronger-than-expected earnings from lending.

Instead of being doomed by an inverted curve, Jamie Dimon and fellow bankers are benefiting from higher rates. JPMorgan’s net interest margin rose to 2.6% for the quarter from 1.8% a year ago. 

Over the past decade, banks’ net interest margins improved when the Fed raised rates. That’s because large banks lifted the amount they pay for deposits at a much slower pace compared with the interest rates they charge borrowers, leaving them with fatter margins.

So why, historically, does an inverted yield curve tend to foreshadow an economic downturn? After all, one closely watched section of the curve, the gap between yields on three-month bills and 10-year notes, has inverted before each of the past seven US recessions.

When the short-term borrowing costs rise above long-term rates, it suggests the Fed’s policy has become too restrictive. It leaves the economy vulnerable to unexpected shocks, as was the case during the pandemic. 

But as banks’ earnings show, the curve itself doesn’t cause a recession.

--With assistance from Daniel Taub.

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