Yield curve flattening and inversion: What is the curve telling us?

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NEW YORK – The US Treasury yield curve has flattened along parts of it as investors price in an aggressive rate-hike plan by the Federal Reserve as it attempts to bring inflation below a 40-year high.

This leaves investors trying to speculate whether this is a bearish signal.

The shape of the yield curve is a key metric investors watch as it affects other asset prices, feeds through banks’ returns and has been an indicator of how the economy will fare. Recent moves have reflected investor concerns about whether the Fed can tighten monetary policy to reduce inflation without hurting economic growth.

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Investors view parts of the yield curve as a bearish indicator, primarily the yield on three-month Treasury bills and 10-year notes and the spread between the US two-year to 10-year curve. However, both of them have swung in opposite directions, causing some confusion as to how accurate they are giving bearish signals.

Other parts of the curve are seen lower, such as the spread between the five- and 30-year Treasuries that turned upside down on Monday and some even turned upside down before the recession.

Here’s a quick primer that explains what a steep, flat or inverted yield curve means and how recessions have been predicted in the past, and what it might indicate now.

What should the curve look like?

The US Treasury meets the federal government’s budget obligations by issuing a variety of debt. $23 trillion https://fred.stlouisfed.org/series/MVMTD027MNFRBDAL Treasury market in Treasury bills with maturities ranging from one month to one year, notes from two years to 10 years, as well as 20- and 30-year bonds Are included.

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The yield curve plots the yields of all Treasury securities.

Typically, the curve curves upward as investors expect to be more compensated for taking the risk that rising inflation will reduce the expected return from owning longer-term bonds. This means that a 10-year note generally pays more than a two-year note because it has a longer tenure. Yields move inversely to prices.

A steeper curve usually indicates expectations of stronger economic activity, higher inflation and higher interest rates. A flattening curve can mean the opposite: investors expect rates to rise in the near term and have lost faith in the economy’s growth outlook.

What does inverted curve mean?

According to the 2018 report https://www.frbsf.org/economic-research/publications/economic-letter/2018/march/, the US curve before each recession since 1955, with recessions between six and 24 months It’s reversed. With an economic-forecast-yield-curve by researchers at the Federal Reserve Bank of San Francisco. It gave a false signal only once in that time.

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The last time the 2/10 of the yield curve was inverted was in 2019. The following year, the United States entered recession – albeit because of a global pandemic.

Why is the yield curve changing now?

Short-term US government debt yields have risen sharply this year, reflecting expectations of a series of rate hikes by the US Federal Reserve, while longer-term government bond yields have moved slower, amid concerns over policy. Tightening can damage the economy.

As a result, the shape of the Treasury yield curve is typically flattened and in some cases inverted.

Parts of the yield curve, namely five to 10 and three to 10 years, inverted last week.

The spread between the five- and 30-year US Treasury yields fell to minus 7 basis points (bps) on Monday, dropping below zero for the first time since February 2006, according to data from Refinitiv.

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The spread has fallen from a positive 53 bps earlier this month. The 5/30 year was the reversal before the 2008-09 recession and before the 2001 recession, but not before the pandemic-induced 2020 recession.

In the overnight index swap (OIS) market, the yield curve between two- and 10-year swap rates inverted for the first time since the end of 2019 and stood at minus 4 bps for the last time, according to Refinitiv data.

Two parts of the curve are watched particularly closely: one is the difference between the yield on two- and 10-year Treasury notes, which is widely seen to predict a recession when it reverses. The spread was at 12.1 bps from 24 bps 10 days ago.

Are we getting mixed signals?

Still, another closely-monitored part of the curve is giving a different sign: The spread between the yield on three-month Treasury bills and 10-year notes is rising this month, leading some to suspect a recession is imminent. .

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Meanwhile, the two-year/10-year yield curve has technical issues, and not everyone is convinced that the flat curve is telling the true story. They say the Fed’s bond buying program over the past two years has resulted in an undervaluation of the US 10-year yield, which will increase when the central bank begins to shrink its balance sheets, sharpening the curve.

The US benchmark 10-year yield rose to 2.55% from the 2.5% marker on Monday, hitting the highest level since April 2019. In February, he topped the 2% level for the first time since 2019.

Meanwhile, Fed researchers pulled out a paper https://www.federalreserve.gov/econres/notes/feds-notes/dont-fear-the-yield-curve-reprise-20220325.htm on March 25, suggesting It was noted that the predictive power of spreads between 2- and 10-year Treasuries to signal an impending recession is “probably spurious”, and that a better harbinger of an impending economic recession is the spread of Treasuries with maturities of less than 2 years. .

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What does this mean for the real world?

While rate hikes can be a weapon against inflation, they can also slow economic growth by increasing the cost of borrowing for everything from mortgages to car loans.

In addition to the signs it can shine on the economy, the shape of the yield curve has an impact on consumers and business.

When short-term rates rise, US banks raise their benchmark rates for a wide range of consumer and commercial loans, including small business loans and credit cards, making it more expensive for consumers to borrow. mortgage rates increase too.

When the yield curve stabilizes, banks are able to borrow money at lower interest rates and lend at higher interest rates. Conversely, when the curve is flat they find their margins squeezed, which can prevent lending.

(Editing by Megan Davis and Andrea Ricci)



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