In my first job as a municipal bond analyst and strategist a key datapoint to consider was the steepness of the yield curve!
When the curve was at its steepest, investors would be ‘getting paid’ in the form of higher yields to assume the price and reinvestment risk of moving out to longer maturities.
When flat, meaning that the spread of longer-term yields to short-term yields had contracted, investors would not be getting adequately compensated and it would therefore not be prudent to extend out to 15 or 30-year maturities.
U.S. Recession Risk
Today the spread between long and short-term yields (2 and 10-year maturities) on the treasury curve are at their narrowest in about eight years at under 100 basis points (1% = 100 basis points) (see chart above)!
Is this fact signaling that a recession in the United States is on the horizon or, would it require a flatter, or even an inverted (bond market condition where long-term yields are lower than short-term yields) yield curve, for that to be the case?
Since the Federal Reserve raised the fed funds rate in December 2015, however, the slope of the yield curve has gotten increasingly flat.
From FT.com…
‘Yield curve recession indicator sends warning on US economy‘
‘The famous economist Paul Samuelson once joked that the stock market had predicted nine of the last five recessions. Investors often retort that professional economists forecast none of them. But the most accurate recession gauge of the modern era is currently blinking ambiguously.
The stock market carnage of January and ructions in the corporate bond market have exacerbated concerns that the underwhelming but long US economic recovery from the financial crisis is about to fizzle out. Both equities and bonds imply a spookily high probability of a recession in 2016, despite relatively few economic indicators looking in the danger zone.
But both markets are infamously poor predictors; especially stocks, as Mr Samuelson pointed out. That fact has recently refocused investor attention on the “yield curve”, the slope derived from US Treasury bond yields of various maturities, which has a superb record of forecasting recessions.
The yield curve has been flat or “inverted” — in other words longer term borrowing costs have fallen close to or below shorter term ones — ahead of every single US economic downturn since the second world war. Lena Komileva, head of G+ Economics, therefore calls this measure the “new Vix”, a reference to the wildly popular stock market volatility index that has doubled as a fear gauge in the past decade.
So what is this uber-forecaster telling us? Taken at face value, the US yield curve is only flashing a mellow yellow. While it is flattening like a bad soufflé — the difference between the two-year and 10-year Treasury yields fell below 100 basis points for the first time in eight years this week — the yield curve is far from inverting. Other popular measures of its slope are also slightly above their 2015 lows…‘
Read the rest of the article at FT.com.
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