Reflecting on November: A flattening US yield curve

Mark Nelson revisits the US yield curve, which, by one measure, is at its flattest level in a decade, and suggests what this might mean for the US economy.

What has happened?

We wrote in August of a flattening move in the US yield curve, and this move has continued in recent months. The spread (difference) between the yield on the US 10-year and 2-year bonds narrowed by 16bps in September, to its lowest level in a decade, with the 10-year yield broadly flat and the 2-year yield rising sharply.

 

Why?

Yields at the short-end of the curve have traditionally been driven by expectations of changes in short-term rates, and this has been the case recently, with expectations of rate rises by the US Federal Reserve driving yields higher. The market-derived probability of the Fed raising rates in December, currently stands at 100%, and expectations are that there will be further increases in 2018 to add to the three in 2017, assuming the Fed hikes in December, and one each in 2015 and 2016. The long-end of the curve, however, is traditionally more sensitive to changes in growth and inflation expectations and flat or declining yields on longer-dated bonds could indicate a lack of confidence in the US economic outlook.

 

What should you take away from it?

Flat yield curves are not uncommon and are not necessarily anything to be concerned about. However, inverted yield curves – that is when long-term yields are lower than short-term yields – can be. Looking back over the last thirty years, every US recession, defined as two consecutive quarters of negative GDP growth, has been preceded by a negative 2 – 10 year spread, so any further narrowing from the current 60bps level should be closely followed.