What is the Yield Curve Telling Us?

The inversion of the yield curve (where short-term rates are higher than long-term rates) is one of the most reliable predictors of a recession. As it happens, the Treasury yield curve is currently inverted with the 10-Year yield (1.6%) well below that of the 3-Month yield (2.0%). So does that mean all signs are pointing to a recession? Not necessarily.

Before previous recessions, the yield curve was inverted along all points of the curve (see the chart below from the Wall Street Journal), meaning it was completely downward sloping with the 10-year yield lower than the 3-month, and the 30-year yield lower than the 10-year. However, today’s yield curve is instead “V” shaped, with the 10-year yield lower than the 3-month, but the 30-year yield back higher than the 10-year. What could explain this “V” shaped phenomenon? The bond market seems to believe the Fed raised rates too aggressively, and will cut rates in the short-term (which is leading to the 10-year rate being less than the 3-month). However, the bond market does not seem to expect a deep recession, resulting in more cuts in rates over an extended time period (such as that would cause the 30-year yield to dip below the 10-year).

As a result, the bond market may be telling us to look out, but for now, seems to be believe we’ll avoid the worst case scenario.

Source: WSJ. For full article click here.

 

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