A Dramatic Yield Curve Transition From a Steep Front to Back End Flatness

The yield curve is nearly flat as a pancake between three years and ten years. The curve has two inversions.

 

Yield Curve data from New York Fed, chart by Mish

 

On Wednesday, the Fed hiked interest rates for the first time since 2018. 

The hike was 25 basis points BPs (a quarter-point hike) as widely expected. 

Yield Curve Comments 

• The front end of the curve is as steep as it's going to get. Every hike will flatten the front end. 
• The Effective Fed Funds rate rose by a quarter point to about 0.33 percent from 0.8 percent.
• At one point on Wednesday, the spread between the 5-year and 10-year notes inverted. The 5-10 spread closed at 1 basis point.  
• The 7-10 spread is inverted by 3 BPs.
• The 20-30 spread is inverted by 10 BPs.
• The 5-10 spread is 1 BP.
• The 3-10 spread is 5 BPs.
• The 2-10 spread is only 24 BPs
• The 3-30 spread is only 32 BPs

Inversion means a shorter-term note has a higher yield than a longer-term note.

Economists watch the 2-10 spread as a recession indicator. 

Treasury Yields December 2021 to Date 

Yield Curve data from New York Fed, chart by Mish

This is a very flat curve between 3 and 30 years and is poised to get flatter as the Fed hikes. 

Yield Curve Spreads Since January 2021 

(Click on image to enlarge)

Yield Curve data from New York Fed, chart and calculations by Mish

Chart Notes 

• Less than a year ago the 2-10 spread was 159 BPs. With only a single hike, the spread collapsed to 24 BPs. 
• Unless the 10-year bond further sells off (yields rise), another quarter-point hike will flatten if not invert the 2-10 spread.

Fed Stops Hiking When 2-10 Inverts 

History shows the Fed generally stops hiking as soon as the 2-10 spread inverts for longer than a month.

The Fed has hiked up to the point of causing a 2-10 inversion, but then it stops. Greenspan managed an additional hike or two one time. 

You have to go back to the Volcker Fed in 1978 to find a major exception. Powell is no Volcker.Let those thoughts sink in as you ponder the Fed's dot plot of rate hike expectations. 

Dot Plot 

(Click on image to enlarge)

Fed Dot Plot of rate hike expectations. Chart from FOMC, annotations by Mish.

The median fed expectation for the end of 2022 is a total of 7 quarter-point hikes in 2022 and 3 or more hikes in 2023.