Commentary on the yield curve has been amplified in recent weeks.
The yield curve is the slope of the plot of yields on U.S. Treasury securities of various maturities. The plots cover the one-month Treasury bill to the 30-year Treasury bond (11 plots in total).
So why has the commentary been amplified, and does it matter?
Market watchers monitor the slope of the yield curve as an economic indicator. The yield curve normally slopes upward -- each successive maturity is higher than the next. This makes sense. Investors usually demand more compensation to commit their money for 30 years than for three months
That said, the slope is an important indicator. The slope of the yield curve has historically borne a consistent relationship with economic activity. The yield curve has predicted all U.S. recessions except one since 1950. When the yield curve flattens, or inverts (short-term rates higher than long-term rates), a recession looms and so does a bear market.
Today, the yield curve is normal, though it’s less normal than it has been in the recent past. A flattening has occurred. When the yield curve flattens or inverts, market watchers worry. They worry because market participants anticipate slow growth and Federal Reserve interest-rate cuts. The prospect of both events tends to drop yields on the long-end of the yield curve.
The spread between two and 30-year Treasury yields -- one of the most-watched measures of the yield curve -- fell to a 10-year low of 137 basis points two weeks ago. This is down from more than 200 basis points at the end of last year.
At the same time, the difference between two and 10-year Treasury yields, another popular measure, has fallen to 80 basis points. This is close to the nine-year low of 75 basis points touched last summer.
The yield curve has flattened, to be sure, but mostly due to the Federal Reserve raising interest rates at the short-end of the yield curve. Meanwhile, longer-term government bond yields have fallen, reflecting ebbing expectations for growth and inflation.
Frightening stuff? Not really. We worry less than most yield-curve watchers.
Although the yield curve has flattened, we see little evidence of market stress. We say that because spread yields on U.S. Treasury, investment-grade bonds, and high-yield bonds remain normal. Besides, the yield curve’s behavior is hardly without precedent. During most Fed hiking cycles, the yield curve has flattened
At this point, we have time before we need to worry about an impending recession or bear market. As long as the yield curve doesn't invert, and it’s still far from inverting, everything should be fine.