Don't Ignore The Yield Curve

Over the past few days, there’s been lots of chatter about the recent flattening of the yield curve. The rising of short term yields with the opposite move at the longer-end has caused the 2 and 5-year portion of the curve to invert. With any inversion, suddenly everyone is a bond trader and has an opinion about what it means for risk assets and the world in general. Of course, the MacroTourist is no exception, but before I throw my opinion into the sea of sound bites, let’s examine how we got here.

Let’s start with the yield curve one month ago.

I am using the active U.S. Treasury yield curve, but they all look roughly the same. As you will notice, back then it was a nice upward sloping yield curve. Every tenor had a higher yield than the previous shorter dated maturity.

But then last week, Federal Reserve Chairman Powell gave his speech where he “blinked” and took a more dovish stance.

What happened to the yield curve? Well, versus a month ago, the front end of the curve ended higher, while the long end fell in yield.

 

This was a flattening of the yield curve. Yet notice how still every longer maturity had a higher yield. At this point last week, the curve was still upwardly sloped.

Yet we can’t say the same today (actually, I am late publishing this piece, so the data is from yesterday - December 5th, 2018)

 

Look at the yield curve. The front end has risen while the long end has kept falling. This has caused the 2⁄5-year spread to invert (meaning the 2-year yield is higher than the 5-year yield).

Here is a chart of the difference between the 2 and 5-year yield:

 

It’s that ticking below the red line that has gotten all the financial news pundits lathered up into a frenzy.

But what does that really mean?

Well, an inversion of the yield curve has traditionally been one of the best indicators presaging a recession. There has been tons of studies and even more conclusions drawn from the data, so you probably don’t need me to rehash them all.

Yet I think it’s amusing to hear all the yield-curve-apologists (a term coined by my colorful pal, Janney’s Guy LeBas in this article) once again claiming that yield curve inversions don’t matter.

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Disclosure: None.

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