Why Are Markets Spooked By A Flattening U.S. Treasury Yield Curve?

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On the latest edition of Market Week in Review, Mark Eibel, director, client investment strategies, and Consulting Director Sophie Antal Gilbert discussed the impact of the U.S.-China trade truce on markets, the flattening of the U.S. Treasury yield curve and November’s U.S. employment report.

Wild week for markets in wake of trade-war ceasefire

At a Dec.1 meeting in Argentina, the U.S. and China agreed to refrain from increasing tariffs on each other’s imports for a period of 90 days. Markets initially rose on the news, with the Dow Jones Industrial Average climbing 287 points on Dec. 3, while the S&P 500® Index finished that day up approximately 1%.“That seems so long ago,” Eibel remarked, “as it’s been quite the wild ride ever since.” Major indexes plunged the following day, Dec. 4, as contradictory reports on the details of the trade-war ceasefire and the progression of the trade talks emerged from both sides. “Dec. 4 appears to have been when reality set in for markets,“ Eibel said, “leading to choppiness that accelerated the rest of the week as the U.S. Treasury yield curve sharply flattened.”

Recession worries rise as yield curve flattens

The yield on the benchmark 10-year U.S. Treasury note dropped dramatically the week of Dec. 3, Eibel said, falling from nearly 3% at the start of the week to 2.85% by mid-week. With the yield on the 2-year Treasury note also decreasing to around 2.75%, the spread between long and short-term yields narrowed considerably—to as low as 11 basis points on Dec. 4.

“Over the last 50 years, every time the yield curve has inverted, there’s been a recession in the U.S. no more than 12 months later,” Eibel said, “which is why markets sold off as the curve flattened.” What really put the market on edge, he added, was that the yield on the 5-year Treasury note at one point dropped below that of the 3-year Treasury note—a momentary inversion. “While most economists define a yield curve inversion as occurring when the 10-year yield falls below the 2-year yield, this did mark the first time in quite a while that we’ve seen a shorter maturity have a higher yield,” Eibel explained. This, in his opinion, led to heightened market worries about when the difference between the 10-year and 2-year yields will become negative.

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