Yield Curve Sign of Weakening Economy? This Time, We Think Not.
The yield curve flattened 64 basis points (bps) in 2017 and 218 bps since the start of this economic cycle.1
Historically, a flattening yield curve has proven to be a sign of a weakening economy and an inverted curve a sign of recession (Figure 1). This is primarily since a flat yield curve has historically served as an indicator of monetary policy tightness and growth expectations.
Figure 1: The Yield Curve Flattens
U.S. Treasury Curve Steepness (1/1/85 – 12/7/17)
Sources: Thomson Reuters Datastream, New York Life Investments, as of 12/7/17. The yield curve is a curve showing several yields or interest rates across different contract lengths. In this case, it is represented by the 10-Year Treasury Constant Maturity Minus 2-Year Treasury Constant Maturity, regions shaded based on the National Bureau of Economic Research (NBER) recessions.
Today, monetary policy is loose, and financial conditions are quite supportive (Figure 2). So, it’s an unusual situation. Extremely low interest rates overseas hold down long-bond yields in the U.S., due to heavy international investor buying. Additionally, unusually low inflation levels for this stage of a cycle raise questions over the peak level of short-term interest rates.
Figure 2: Financial Conditions Remain Very Accommodative
Financial Conditions Index (1/1/85 – 12/1/17)
Sources: Thomson Reuters Datastream, New York Life Investments, as of 12/6/17. The Chicago Fed’s National Financial Conditions Index (NFCI) provides a comprehensive weekly update on U.S. financial conditions in money markets, debt, and equity markets and the traditional and “shadow” banking systems.
The yield curve behavior bears watching, but for now, we don’t see a reason for alarm, as low-bond yields have a stimulative effect on the economy, offsetting the impact of Fed hikes.
1. End date = 12/7/17. Start date = 12/30/16 and 2/22/10.
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Basis points (bps) refer to a common unit of measure for interest rates and other percentages in finance. One basis point is equal to 1/100th of 1%, or 0.01% (0.0001), and is used to denote the percentage change in a financial instrument.
A yield curve is a curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.
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