The Flattening

The Earth may be round, but the U.S. Treasury yield curve is certainly flat! The flattening trend has many industry participants fearing what this development might portend, especially if the yield curve inverts. Historically, an inverted yield curve has “predicted” a U.S. economic recession every time during the last 50+ years. Unfortunately, the period from inversion to the recession has taken as little as 14 months to as much as 3 years to occur. During the 18-months following the inversion, the U.S. equity market has returned nearly 15% on average.

According to Jonathan Golub, Credit-Suisse, we are experiencing the flattest period since June 2007. As a point of reference, “in early February, the yield curve (2-10 year spread) stood at 78 bps. Today it is only 12 bps”. However, despite this recent decline in the spreads, futures point to relatively little change over the next couple of years.

According to an analysis conducted by Ron Ryan, Ryan ALM, the Treasury yield curve was last inverted on February 27, 2007, which showed a -31 basis point differential between 2s and 10s. Furthermore, the 1s-30s spread was last inverted in January 2007 at -6 bps.  The greatest differential in the 1s-30s spread occurred in March 1980 (I think that I was on Spring break in Virginia at that time) when the spread hit -281 bps. The lowest spread in the 2s-30s was -54 bps, which occurred in March 1989.

While the U.S. Federal Reserve has been successful in “normalizing” rates on the short-end (2.25% Fed Funds rate) the rest of the world is still sitting with negative real rates (Germany and Japan to name a couple). Can the U.S. remain the sole growth engine globally? Currently, U.S. recession indicators are muted, but there are signs that growth is slowing. We’ve recently seen indications of this in housing and commodities.



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