At present the Treasury yield curve (duration on X-axis, yield on Y-axis) is extremely flat and yesterday the 10 year yield was at times just slightly lower than the 2 year yield conjuring suggestions of curve inversion. What does this imply?
A flat yield curve or especially an inverted one (when the 30-year yield is less than the 10-year yield) is generally a sign of slow economic growth or a precursor to recession. There is little mystery to the present flat yield curve. Fed hiking has driven up the short end (durations up to two years). The long end (10 and 30 year) is market driven and the driving force is inflation or the lack thereof. Understand this point: the Fed drives the short end, the market drives the long end (10 and 30-year durations). The short end is in flux (rising) from belief that Fed hiking is not over. The long end is static because of controlled inflation. Shortly after the Fed stops hiking, yields at the longe end are likely to increase. That will be because investors will be concerned about inflation absent the controlling force of rate hikes.
Might this be a sign of economic weakness (slow or no GDP growth)? Maybe. But now is not a time to judge from the shape of the yield curve. If one waits until about 2-3 months after the Fed stops hiking the shape of the yield curve will have more meaning as a predictor of economic activity. Right now the shape of the yield curve tells us little about the future of the economy. The low level that this flat curve is at tells us that investors believe inflation to be contained.
Treasury yields and mortgage rates are discussed daily on my web site.
- Dick Lepre