Why the Yield Curve Inverts in One Simple Picture - Mish Talk

Andrew Cummings
December 8, 2018

"There can't be another screwup like last time, when they dropped "accommodative" but simultaneously characterized the Fed funds rate as "a long way" from neutral", Gundlach said.

"The US economy is likely to be able to withstand another rate hike or two, therefore the flattening of the Treasury curve looks a little over done". A yield curve inversion preceded both the first tech bubble and the 2008 market crash.

- CNBC's Sam Meredith and Ryan Browne contributed to this article.

Earlier this week, interest rates on 3-year Treasury notes turned higher than 5-year rates for the first time since the dawn of the previous US recession, back in 2007. The Australian dollar was down 0.5 per cent at $0.7307.

Furthermore, in the credit markets, he highlighted the borrowing costs of high yield businesses had increased by over 1% and 0.25% for investment grade companies.

Global stocks sank and the dollar fell on Tuesday as a flattening Treasury yield curve sparked recession warnings, while optimism that the USA and China would quickly resolve their trade dispute dwindled. A recession isn't destiny, in other words: The Fed could respond to the yield curve's signal by cutting rates to head off the recession. "We are following a strategy and taking account of data over time as it comes in and in response to significant changes in direction". The longest-duration Treasury bond (meaning fixed-interest debt backed by the US government) is 30 years.

According to Forbes, the Fed has played a major part in suppressing long-term interest rates while raising short-term interest rates.

Though it is not certain the narrowing in spreads is related to doubts about economic growth, alternate explanations would not necessarily be helpful to the Fed either. Stock and bond markets will be closed on Wednesday.

According to the San Francisco Fed, each of the nine US recessions that have occurred since 1955 came between six months and 24 months after a an inversion in the yield curve of two-year and 10-year Treasury yields.

But since then, it has persistently declined, especially since the middle of last week, and now is at its narrowest since July 2007, on the eve of a steep recession. The yield curve has flattened as continuing interest rate hikes send short-dated yields higher, while longer-dated Treasuries are supported by tepid inflation and slowing global growth.

Markets are also bracing for more news on the Brexit front. The Big One will be when 2-year and 10-year Treasury rates swap places, and bond traders are doing their darnedest to make it happen soon, as Robert Burgess points out.

On Monday, two- and five-year Treasury yields inverted, meaning the shorter-dated two-year money became more expensive than the later-maturing five-year.

The outlook for USA growth, by contrast, he said remained strong.

The Cleveland Fed, meanwhile, has focused on the difference in yields between three-month Treasurys and 10-year Treasurys.

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