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Why the Markets Are Worried about the Yield Curve

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Yield spread fell to the lowest level since 2007

The spread, or the difference between the yields of the ten-year US Treasury and the two-year US Treasury (BND), has fallen below 50 basis points for the first time since 2007. In 2007, the US economy was on the cusp of entering a recession, and the slope of the yield validated itself as an indicator of future recessions. Market participants have been debating the validity of this indicator since recent economic data are projecting a healthy outlook for the economy. In the chart below, you see the spread between the ten-year and two-year Treasuries.

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Understanding the yield curve

According to Investopedia, “A yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality but differing maturity dates.” The most common yield curve traced by the investing and academic communities is the U.S. Treasury (GOVT) curve that plots the yields across various maturities. A normal yield curve is upward sloping, and long-term yields are higher than short-term yields. Depending on the change in yields, the curve could flatten or even invert due to uneven changes at various maturities along the curve.

When does a yield curve invert?

Since the beginning of 2018, the uneven change in yields has increased, and short-term yields have increased faster than long-term yields. For instance, the two-year Treasury (SHY) yield has increased by 61 basis points, while the ten-year and 30-year yields (TLT) have increased by 45 and 24 basis points, respectively. That resulted in the flattening of the yield curve, causing concern that the yield curve could invert if the trend continues. In this series, we’ll look at this warning signal from the bond (AGG) market and see what key members of the FOMC (Federal Open Market Committee) think about the yield curve flattening.

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