If you haven’t been paying attention to the persistent flattening of the U.S. yield curve, you’re way behind it.
Peter Cecchini, chief market strategist at Cantor Fitzgerald, calls it “the most important thing to have a clear idea about now.” Billionaire fund manager >Bill Gross says we’re rapidly approaching a point at which the trend will induce an economic slowdown. Others claim it’s only natural, with the Federal Reserve raising short-term interest rates in the face of stubbornly low inflation.
To put it simply, the Treasury yield curve measures the spread between short- and long-term debt issued by the U.S. government. It’s the extra compensation that investors demand to lock away their money for an extended period.
No matter which theory of flattening you subscribe to, the world’s biggest bond market is sending a signal that traders can’t ignore. The longer the trend continues, the more likely its effects could spread to bank earnings and the real economy, while at the same time it would limit the Fed’s ability to respond when these risks emerge.
To get a sense of just how dramatic this trend has been, here’s a look at a handful of curve measures now versus the start of 2017. In trading Monday, they were all close to the flattest levels in a decade.
From two years to 10 years: 72 basis points, down from 125
From two years to 30 years: 119 basis points, down from 187
From five years to 10 years: 33 basis points, down from 52
From five years to 30 years: 80 basis points, down from 114
Everyone has their favorite theory for why this is happening and what it means for the economy and the markets, and all of them likely play a part so here’s a breakdown of each one:
It’s the Fed’s Fault
The simplest reason for the flattening comes from looking separately at what’s going on with short rates, the most sensitive to Fed policy expectations, and longer-term yields, which take their cues from the outlook for inflation and economic growth.