Is The Shape Of The U.S. Treasury Yield Curve Warning That A Recession May Be Imminent?

By | October 23, 2017

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Back in the 1980’s when working as a municipal bond analyst, I would keep investors informed about the shape of the tax-free yield curve!

If the yield curve was positive and steep, or in other words a significant difference between short and long-term yields, then investors would be getting compensated for taking on the additional risk that buying 30-year bonds would entail.

The higher yields at the long-end of the curve would tend to be indicating a strong economy with fears of increasing inflation.

For investors of course there would be times when medium-term maturity bonds (10-year) were more attractive and, when the curve was flat, when short-term bonds were the most strategic place to be buying.

And if the yield curve were ever to invert to where short-term bonds had higher yields than long-term bonds, that scenario would be considered a signal of an impending recession.

Removing municipal market supply and other issues from the equation, the shape of the treasury yield curve would tend to move with a similar shape.

Today, given the recent hikes in the fed funds rate (that many economists felt were long overdue) based on employment, inflation and economic activity indicators, should we conceptually be expecting that the yield curve would be steepening?

What, If Anything, Is The Current Shape Of The Treasury Bond Yield Curve Telling Us?

While we might be expecting a steepening yield curve, in fact the yield curve is not and instead is flattening as the short end of the market is betting the Fed will hike two more times while the long end seems to be betting that the tepid economic recovery of the past 5 or so years may be coming to an end!

From Bank of America rates strategist Shyam Rajan: ‘The rates market is sending diametrically opposite messages over the last few weeks. The front of the curve is increasingly confident about a Fed that will hike not only in December but at-least two more times next year. But, the flattening in the intermediate to long end of the curve is sending a clear end of business cycle message.

So where do we go from here? The stock market is at record highs betting on tax cuts and the fact that the Trump economy will grow at a 3%+ rate not seen for the past 8-years, for the foreseeable future.

Will that be the case? Historically the smart money has always beed considered to be in the bond market.

Given that fact, unless that theory is reversing and the stock market will lead the way, the yellow caution flag should be out!

2-yr treasury yield: 1.56%

10-yr treasury yield: 2.38

Spread: .82 basis points – This is just above a post-financial crisis low!

what is an inverted treasury yield curve telling us? Recession?

Source: Driehaus Capital

Michael Haltman, President
Hallmark Abstract Service

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