E Yield Curve Conundrum

Let’s start by taking a look at the following chart, comparing the spread between the Ten Year and the Two Year treasury yields (using that as a proxy for the yield curve in general) and the price of gold.

As you can see, the spread between the two Treasury maturities has continued to flatten and is barely off its low.

Generally speaking, a flattening curve is a sign of a slowdown in overall economic growth. In the past, whenever the yield curve has become inverted (long term rates fall BELOW short term rates) a recession has followed soon afterwards.

I have noted in previous posts about this topic that given the current state of abysmally low interest rates, it is next to impossible for the curve to flatten further to the point of becoming inverted.

Also, during a time of a flattening yield curve, inflationary pressures are non-existent. If they were, bond yields, especially on the back end of the curve would rise causing a steepening of the overall curve.

It is evident that this is not happening.

Yet, today, we got the CPI number which showed some real signs of inflationary pressures building in the economy here in the US. Yet bond yields, instead of rising, actually moved lower during the hours immediately after the release of the data. So what gives?

I have been spending a fair amount of my spare time in analyzing this and attempting to ferret out some sort of meaning to all this. In the past, one of my favorite indicators for gauging the health of the US economy was this same yield curve. Now, suddenly, after all these years of faithful service, it seems to be abandoning me. This has disturbed me greatly.

The reason is has it because over the course of my trading career, I have come to place great stock in the ability of the bond market traders to cut through all the BS and noise taking place in the financial arena and honing in on what really is taking place in the actual economy.

Now I find myself questioning their ability to do just that anymore.

As noted in a previous post – we cannot have commodities as an asset class moving higher in anticipation of inflationary pressures building in the economy while we simultaneously have a yield curve that continues to flatten. The two are mutually exclusive of each other.